72 MONEY.COM MARCH^2019
JOHN BOGLE / 1929— 2019
idea, and, in fact, it was challenging to pull off: At first, the fund had
only enough assets to buy about 280 of the index’s 500 stocks, Bogle
later wrote. And the small Philadelphia company running it was
less than two years old, with a boss—Bogle—who had been fired
from his previous job. “When Vanguard started, it was a very risky
kind of thing,” recalled Bogle in an interview with MONEY, speak-
ing of the early prospects for his company.
The index fund wasn’t Bogle’s invention—a few funds running
money for institutions and pensions got there first—but First
Index made it accessible to individuals with relatively small
amounts to put into the market. (The minimum investment was
about $6,000, in today’s dollars.) Its costs would be low, at 0.4% per
year early on compared with the 1.5% others charged. Still, despite
immediate praise from the likes of Nobel Prize–winning economist
Paul Samuelson, it was slow to catch on. As Bogle liked to point
out, his fund had literally no competition in indexing for about
eight years.
By the 1990s investors started to notice. For a time, simply by
tracking a rallying bull market, the 500 fund was beating the
majority of fund managers by such wide margins that Bogle had to
warn investors not to expect the fund to win every year. The issue
came up again after 2014. “Index funds had a fabulous year last
year. It’s not going to happen again, maybe ever,” said Bogle in an
interview with MONEY published in 2015. “You shouldn’t buy an
index fund because you think it’s a hot performer. Buy it because
you’re going to hold it forever.” Indexing wins not because of some
magic formula but simply because, as Bogle often explained, the
average active fund manager over time is likely to match the
market’s average—and then trail it after charging investors fees.INDEXING’S GROWTH
VANGUARD IS NOW A GIANT ASSET MANAGER, with over $5 trillion in
customer accounts. Its Total Stock Market Index Fund, a broader
portfolio that includes smaller companies in addition to blue
chips, has over $600 billion in assets as of January. As a group,
index funds constitute nearly half the assets held in U.S. stock
mutual funds, and they are a staple of 401(k) retirement plans.
Little wonder: According to a 2018 report by fund researcher
Morningstar, only about one in three active stock fund managers
had managed to outperform comparable index funds over the
previous 12 months.
“In nautical terms, a high-cost fund is sailing into a hurricane,”
said Bogle, who dubbed Vanguard employees its crew and named
the company after one of Admiral Horatio Nelson’s flagships.
Bogle retired as Vanguard’s CEO in 1996 but maintained an
office at the company’s suburban Philadelphia campus and a busy
writing and speaking schedule. His zeal for plugging the virtues
of indexing and low-cost investing—and his attacks on othermanagers’ fees—earned him the (sometimes
grudging) nickname “Saint Jack.”
At Vanguard, Bogle’s low-cost legacy lives
on. According to the company, its average
expense ratio is 0.11%, compared with just
over 0.6% for the industry. That’s not just
because of index funds: Vanguard runs a
number of popular active funds, including
the storied Wellington fund, priced at 0.25%.
Costs may seem a persnickety worry, but
Bogle understood how tiny-looking, tenths-
of-percentage-point differences in fees added
up. The standard practice of pricing funds in
small percentages of a big number, instead of
in dollars, makes it hard to see the real cost.
“We have the miracle of compounding
returns overwhelmed by the tyranny of
compounding costs,” he said.
In fact, paying 1% for $100,000 in a fund
costs $1,000 in only the first year. And over
30 years, it consumes 26% of your potential
wealth, assuming the fund’s return before
fees matches the market, compared with 6%
if you pay just 0.2%. It also obscures the
large fee revenues companies can take in at
investors’ expense. “The whole cost struc-
ture of this industry is insane,” he said,
pointing to profit margins near 50% for some
money managers. “The returns on capital
are for the owners of the management
company. They’re huge.”
Costs can also distort investment
decision-making. They may drive both retail
fund investors and fund managers to take on
more risk, as they reach for higher returns to
overcome the burden of costs. Bogle once
calculated that a 50% stock/50% bond
portfolio with low expenses would have the
same expected returns as a riskier 65%
stock/35% bond allocation with very high-
cost mutual funds. “Asset allocation and
costs are tied together,” he said.
Fund companies’ hunger for assets and
fees has driven waves of faddish products,
from Internet funds to esoteric bond
strategies to ETFs that use high-risk
leverage to deliver twice the returns of the
S&P during bull runs. It also has contributed
to the rise of celebrity fund managers, whose
returns can be touted in advertising and in