Middle America’s most unsung financial hero passed away at the age of 89 on January 16. Jack Bogle, founder of Vanguard and the creator of the world’s first index fund, might not be a household name, but he deserves far more credit than any politician or celebrity who claims to be helping the middle and working classes.
Investing Was Tough In The ‘70s
In the 1970s, individual investing in stocks was quite the challenge. Investors had to pick winners and losers, and some even tried to time the market to maximize their return. They had to guess when company A was going to have a good year, and buy, and when company B was going to have a bad year so they could sell.
Another option was combing through a company’s financial statements and investing in companies that appeared to be undervalued. A third option was to diversify into multiple different asset types and hope they provided a positive return in the long run, but the average worker looking to save for retirement wasn’t an expert in investing. How would he know he was making wise investments?
This was all a lot of work or a lot of risk, even for diversified portfolios, so investors usually picked an investment firm that would do it all for them. They charged a variety of fees, even during down years: about 1 percent per year for the privilege of working with the financial advisor and another 1 percent per year for fund’s own fee. On top of that were load fees and other hidden expenses that would often leech off investor returns.
An actively managed fund is judged based on whether it outperformed or underperformed the total market. Overall, only one in 20 mutual funds end up in the outperforming column. This raised the question: If only 5 percent of actively managed funds beat the market and were typically charging lofty fees regardless of their performance, how would investing change if one simply tried to match the market?
Bogle answered that question by creating Vanguard and the index fund in 1975. An index fund is just a capitalization-weighted benchmark that tracks broad-based changes in its market segment. Put simply, it copies a whole market. Since winners and losers no longer had to be picked, a well-paid fund manager was no longer needed, leaving the Vanguard total stock market index fund (VTSAX), which essentially tracks every publicly traded company, and the S&P 500 index fund (which tracks the largest 500 companies), with an expense ratio of just 0.04 percent.
This meant average investors could invest in the entire U.S. stock market and outperform 95 percent of professionally managed funds while paying a fraction of the fees these professional managers charge to underperform.
Fees are extremely consequential to compounding investments. Let’s say Declan has $100,000 to invest at the age of 30. Declan invested his $100,000 with an investment advisor who charges him 1 percent each year for her services and places his money in an actively managed fund that has a 1 percent expense ratio.
The fund does great. In fact, in the long run, it outperforms 95 percent of its peers, so grants a real return (inflation-adjusted return) of about 7 percent per year. After adjusting for fees, the net return is about 5 percent. So Declan sees his money grow over the years and never touches it. By the age of 65 and with the magic of compound interest, it’s grown to more than $550,000 of today’s dollars. That’s pretty great, right? Well, let’s compare that to Elaine’s investment.
Elaine also has $100,000 to invest at the age of 30, but she invests the money herself in a total stock market index fund or S&P 500 index fund. As we know, either of these funds also outperforms 95 percent of mutual funds, so both see the same 7 percent real return. After adjusting for the 0.04 percent expense ratio, her net return is 6.96 percent per year. She also doesn’t touch the money and allows it to grow.
By the age of 65, it’s grown to $1,115,000. Low-cost index funds allowed Elaine to more than double her money in comparison to an actively managed fund that outperforms 95 percent of other actively-managed funds––and the specialized knowledge required to achieve that result was basically zero.
Index funds are so successful that Warren Buffet stated in his annual letter to Berkshire shareholders that, upon his death, he’s directed his trustee to put 90 percent of his estate in a “very low-cost S&P 500 index fund…I suggest Vanguard’s.” Check out your 401(k)/403b/457 investment options, IRA investment options, taxable brokerage investment options, and HSA investment options. Chances are, you’ll see an index fund listed. While it may not be through Vanguard, it all started with Jack Bogle.
Leaving As Much As Possible For The Investor
At a time fund managers were raking in billions from their clients and leaving very little return for the clients, Bogle’s new approach not only consistently outperformed actively managed funds, but left as much as possible for the investor himself. These funds eventually grew to represent 45 percent of all stock market investments.
Imagine that: DIY investing that consistently outperforms the professionals. The index fund enables millions of Americans who know nothing about investing and may not be able to afford a “good” fund manager to grow their nest egg at the same pace as the overall stock market. That’s wealth they can use to start their own businesses, fund their retirement, and make sure their families and communities are provided for.
Every politician has promised hardworking Americans new opportunities or more entitlements. Some of these policies can benefit some people, but Social Security’s expensive safety net just doesn’t even compare to the power Bogle handed to those same Americans to provide for their own futures.
Let’s raise a glass in honor of Bogle. Although he may not be a household name, he did more to empower the average American than any fiscal policy or best-selling investment book ever could.
This article is not meant to give specific investing advice and is merely informational. Invest at your own risk.