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John (“Jack”) C Bogle died yesterday, at the age of 89.
I don’t think it’s an exaggeration to say that during his lifetime he probably did more to improve the returns of private investors than anyone else on the planet. Warren Buffett agrees with me.
How? Because he pioneered index funds. As founder and chairman of Vanguard Group, he created a way for ordinary investors to bypass expensive fund managers and generally still make more money.
So if you own a tracker fund or an ETF, raise a glass to Jack tonight.
Jack Bogle’s key insight
Jack Bogle’s key insight was a mathematically simple one.
If you add up all the investors in a market, then, on average, they can only make the market return. After all, they are the market.
And if that’s the case, then what the average investor ends up getting in their pocket at the end of the day is the market return, less their cost of investing.
So unless you know that you can pick an above-average active fund manager (which is possible, but neither certain nor easy), then you would be better off aiming to get the average return and keep your costs as low as possible.
That’s the logic for using an index-tracking fund. And it works. While active funds can beat the market (depending on which statistics and timescales you use), it’s rarely by a sufficient amount to offset their fees. So on average, index funds beat stock-picking funds.
And the nice thing about indexing is that you can also have a certain amount of certainty about the return you’ll get. Yes, you’ll get the market return – whether that be down 30% or up 25% – and you can’t predict that.
But you won’t wake up at the end of a stonking year for the stockmarket, only to find that your manager is the one person who missed the rally. (Which should also help you to resist the temptation to chop and change funds quite as often – when there is no fund manager to lose confidence in, there’s not much reason to move.)
Of course, this isn’t a popular message with the active fund management industry. Indexing is taking a massive share of their business, particularly in the US, where it’s becoming an ever-bigger component of the market. (Unfortunately, it’s not as prevalent in Europe, where investors are still losing huge sums of money to fund management fees, as I covered earlier this week.)
Fears about the effects of indexing have been around for a while
The financial industry is constantly talking up the dangers associated with indexing. It’s being blamed for everything from creating imbalances that will result in the next big collapse in financial markets, to the erosion of shareholder capitalism and the rise of monopolies.
Here’s a quote for you, one that I cited to Merryn on our most recent podcast (have a listen here if you haven’t already). I’ll tell you who it is in a moment.
“There is no question that indexing exacerbated the market movement upward. If we have a bad year or two it is easy to envision that institutions that had money in indexing might pull it out en masse, exacerbating the decline.”
That’s a convincing argument, and one that I’ve actually a lot of sympathy with. I don’t think it’s unfair to argue that index funds and exchange-traded funds (ETFs) in particular provide a route through which money can enter and leave the market even more rapidly than before.
Indeed, Bogle himself was not keen on ETFs as he felt they encouraged over-trading. He not only understood the importance of costs, he also grasped the frailties of investor psychology and its ability to ruin the best-laid retirement plans of any of us.
However, take a guess as to what date that quote comes from. I’ll give you a minute.
Had a go?
It’s from an interview with US newspaper Barron’s, in which value investor Seth Klarman (one of the few active managers with an astonishingly good record) expounded on his many fears about the market. That interview was carried out in November 1991.
In case you’re wondering, the US market was never, ever as low again as it was when that interview with Klarman was published (the Dow Jones was moseying along around 3,000 at the time).
So whatever else indexing did for the market at that point, the 1987-style waterfall of selling that investors like Klarman feared never materialised. That’s not to say that it never will, but it is worth pointing out that people have fretted about the impact of indexing on markets ever since it was introduced, even before it became anywhere near as popular as it is now.
So I’m not saying you shouldn’t invest in active funds. We like investment trusts as a vehicle, and we like many individual trusts – we’ve even put together a MoneyWeek investment trust portfolio.
However, if you aren’t willing to do the legwork to choose a suitable trust, and you just want to invest in a diverse portfolio of equities, then index funds are the perfect vehicle for doing so. They’ll save you money, and over a long period of time, could make you tens of thousands of pounds better off in retirement.
And for that, we have Bogle to thank.