Happy Birthday to a Great Investing Idea
Today, one of our favorite financial journalists, Jason Zweig of the Wall Street Journal, reminded us that it was forty years ago this week when John Bogle introduced Vanguard’s S&P 500 Index fund to the investing public. Although technically not the first index fund to exist, it was the first one made available to a wide audience. Starting with just $11.3 million of assets (well short of the $150 million target set by Bogle), it met with a large amount of skepticism. Often derided as “Bogle’s Folly”, some critics went so far as to call it “un-American”, an especially harsh put-down in the Bicentennial year of 1976. The basic idea behind that criticism was the acceptance of merely average returns. Of course, these “average” returns would turn out to be well above the average return earned by all investors who paid unnecessarily high costs and engaged in destructive behaviors. The "un-American" criticism was recently echoed by Sanford C. Bernstein & Co. arguing that passive investing is "worse than Marxism" in a note to clients.
As we all know, the rest is history. Today, the Vanguard 500 Index Fund holds more than a quarter of a trillion dollars, while index mutual funds and exchange-traded funds (ETFs) control nearly $5 trillion in combined assets. While there have been many positive developments that originated with indexing such as funds built around capturing risk factors, unfortunately, there have been some that we view as negative. Some examples that come to mind are leveraged/inverse ETFs as well as ridiculously specialized ETFs in areas like casinos.
Part of the academic inspiration for index funds came from the late Paul Samuelson of MIT who wrote an article in 1974 called “Challenge to Judgment” which argued that investors looking for superior stock pickers were engaged in a fool’s errand. Samuelson quipped, “A respect for evidence compels me to incline toward the hypothesis that most portfolio managers should go out of business—take up plumbing, teach Greek, or help produce the annual GNP by serving as corporate executives.” In the 42 years since Samuelson wrote that statement, many portfolio managers have indeed thrown in the towel. For their part, investors have wisely chosen to put more of their dollars into passive funds, especially in the last few years. At Clarity, we see every reason for this beneficial trend to continue.