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Bogle is Founder of The Vanguard Group, which launched the first index mutual fund, the Vanguard 500, in 1975. The Vanguard Group now has 21 index funds and manages some $550 billion in assets. Q&A's, excerpts from his speeches and other materials will appear periodically in this space. A recent discussion between Editor Jim Wiandt and Mr. Bogle is the basis for this inaugural column. |
Wiandt: What was the most significant obstacle you had to overcome to be successful with the Vanguard index funds?
Bogle: We had to overcome public opinion and industry horror about the idea, called "Bogle's Folly" in the beginning. When our Index 500 Fund began, it was criticized by virtually everyone. Inertia was the biggest problem-we had to get across the idea of indexing as a way of investing, not merely a product. It has increasingly become a product, and I don't really like that. But such a large change in the way people think always takes some getting used to.
Wiandt: When it first came out, people were talking about it being communism, that this isn't the free market.
Bogle: Yes, communism. The rewards go to the owners, not the managers. "Stamp Out Index Funds," as the poster outside my office says. The other thing is that many investors didn't understand investing well enough to know that as a group they cannot win. Indexing is based on a very simple formula: gross return minus cost equals net return. And you know what? Investors as a group lose by the exact amount of their costs…which are about a billion dollars a day. So did indexing win today? Yes, it won today, and by another $1 billion. It's pretty easy. And I don't care what the data say. The data say that indexing wins…but it wins by much more than the data show. Because the data have survivor bias, incubation bias, and cash flow bias (many investors buy high and sell low), which results from the fact that investors' dollar-weighted returns are a fraction of the funds' advertised time-weighted return. Indexing wins by so much that it's staggering.
Wiandt: To you, what is the definition of good index fund management?
A: No index fund management. Don't do something. Just stand there. That's essentially what you can do in a total stock market index. You can buy the stocks in the appropriate weight, and if there's a merger, that doesn't do anything at all to the index, you don't have to change anything in the fund. There are no changes. It just takes care of itself. A bit of rebalancing might have to be done if a company gets bought out for cash, for example, but that rarely happens to any of the larger companies. An S&P index fund, on the other hand, requires a small amount of management. When a new company is added, a small company usually goes out, and requires only a very small reduction in all of the other 499 holdings. So I don't believe in managing indexes. I believe the idea of indexing in its purest form is to keep your hands off the portfolio. Now in bond index funds you can't buy the whole bond universe. There are just too many bonds to do so efficiently. So you match it as well as you can. But do it to match the characteristics of the index. And never put a bond in there that yields a little bit more. If you do that, surprise! It has more risk. So don't go there ever.
