Index Investing: John Bogle

|| This article is Part Three in a series on investing with index mutual funds. ||
||   I. SpeculationII. Index FundsIII. John BogleIV. Vanguard   ||
||  V. Moving to VanguardVI. Asset AllocationVII. Maintenance  ||

Few of the financial innovations of the last century were particularly beneficial to Average Joe Investor. Complex new investment vehicles, such as the mortgage-backed securities that precipitated the Crash of 2008, have allowed unscrupulous stock brokers to repackage and sell high-risk garbage investments to unsuspecting individuals and institutions.  High fees and hidden costs have siphoned an ever-increasing proportion of market returns away from the investors and into the pockets of fund managers and the titans of Wall Street.  High-frequency trading by supercomputers has distorted the short-term market landscape in unexpected ways.  Hedge funds have made their proprietors billions, but overall have paid out rather poorly to their exclusive clique of megarich patrons.

Amidst all of this 'high finance' dreck, one innovation stands out as an obvious win for the investing Everyman: John Bogle's invention of the index mutual fund.  Far from being met with universal praise, Bogle's big idea was roundly derided by the financial establishment.

38 years later, investments in index mutual funds make up 28% of the $13 billion in US mutual funds.  Well done, Mr. Bogle.

Inventing the Index Fund

(see Wikipedia, Index Fund: Origins for the full story)

Bogle graduated from Princeton in 1951, at a time when the only kind of mutual fund was the actively-managed stock-picking fund.  His belief that the mutual fund industry was broken was reflected in this senior thesis, entitled: "Mutual Funds can make no claims to superiority over the Market Averages."  After being inspired by several articles on indexing that supported his thesis research, he founded the Vanguard Group and started the First Index Investment Trust on the last day of 1975.

Bogle's active-management competitors called his ideas "un-American" and referred to his fund as "Bogle's Folly."  Fidelity Investments Chairman Edward Johnson's opinion reflected the perspective of the era: "I can't believe that the great mass of investors are going to be satisfied with receiving just average returns."

The fund was renamed the Vanguard 500 Index Fund |VFINX|, and sought to track the S&P 500 domestic stock market index.  It grew slowly at first, but broad diversification and significantly lower fees allowed it to outperform many of its competitors and the notoriety of Bogle, Vanguard, and the index fund concept continued to increase.

Bogle's Triumph

Investors have gotten Bogle's message that costs matter, and have embraced the advantages of index funds.

Today, Vanguard is the world's largest mutual fund company and one of the world's largest investment management companies, with over $2 trillion under management.  More than a quarter of the money in mutual funds is invested in index funds, and this value continues to grow.  The Vanguard 500 Index, now with over $140 billion in assets, is one of the largest mutual funds in the world.

The investment services company Morningstar publishes a regular report called the 'Fund Flows Update', in which they monitor the flow of money between types of securities and investment firms. The trend over the last decade is very clear: investors are leaving expensive, actively-manage funds in droves and piling money into low-cost index funds.

Vanguard, originator and champion of the index mutual fund concept, is a huge winner; firms that specialize in high-cost funds with sales loads, such as American Funds, are the big losers.

This graphic from the December 2012 report tells the story:

Bogle's Library

John Bogle has spent his entire career fighting for financial management transparency, corporate responsibility, and the rights of the small investor.  He has authored several books on these topics, several of which are great reads to better understand the climate in today's financial industry:

The Little Book of Common Sense Investing

The Bogleheads

Fans of Bogle's ideas have christened themselves 'Bogleheads' and formed an investment interest and education group.  They run a top-notch investment education wiki, with excellent articles on getting started in investment.

The Bogleheads have also published two excellent books on investing:

In the financial world, the heroes looking out for the interests of the little guy are few and far between.  John Bogle is one of those heroes.

A few more articles, for those interested:
Investment News - John Bogle has already won
New York Times - A Mutual Fund Master, Too Worried to Rest
PBS - The "Train Wreck" Awaiting American Retirement