Twenty-five years ago the concept of indexed investing was derided by professional investors as a path to mediocre investment returns. Why buy the market when you can beat the market? That was their argument.
But one of the pioneers of retail mutual fund indexing, former Vanguard Group Chairman John C. Bogle, has had the last laugh. Index funds he launched at Vanguard have beaten the average mutual funds since they were formed.
The Vanguard S&P 500 Index fund, which was founded in 1976, has had an annual average return of 13.2% since that time, beating the 12.6% return on the average equity mutual fund that survived from 1976 to now. If the funds that went out of business during that period were included, the average fund’s return would have been closer to 11.1%, giving the Vanguard fund an advantage of 2.1%.
Vanguard’s Total Bond Market Index Fund returned 8% per year since its inception in 1986, beating the 7% return on the average bond fund during the same period.
The consistent performance of indexed mutual funds has won over a lot of converts, Bogle told attendees of the Sixth Superbowl of Indexing conference last December. In 1981 indexed funds held $6.5 billion in assets, or about 1% of all U.S. stocks. By 2001 the holdings of indexed funds had grown to $1.3 trillion, about 10% of the market value of all U.S. stocks. Pension funds were early converts to fund indexing. Some 23% of all pension funds assets are now indexed. Individual investors took longer to get on board but finally did in the 1990s, pushing the holdings of indexed mutual funds to 12% of all stock mutual fund assets.
Bogle says the triumph of indexed investing is being threatened by its misuse. “Increasingly, and to an astonishingly unrecognized extent, indexing is being used, not to match the market but to beat it,” he told the conference. Bogle said investors should use index funds to take advantage of the long-term positive returns of the markets. Anything less than that is dangerous. “When investors, in the hope of carving out an edge, use index funds to make outsized bets on narrow market sectors or to vigorously trade their portfolios, they have adopted the ultimate losers’ strategy,” Bogle said.
