John Bogle's "Experiment in Human Values" (Fool on the Hill) February 28, 2000

An Investment Opinion

John Bogle's "Experiment in Human Values"

By Yi-Hsin Chang (TMF Puck)
February 28, 2000

"What's the point of looking for the needle in the haystack? Why not own the haystack?" -- John Bogle, founder, Vanguard Funds

I had the privilege earlier this month of attending a talk by one of the giants of investing. The speaker was none other than John Bogle, founder of mutual fund company The Vanguard Group. Mr. Bogle's talk provided an important reminder of the power of index funds.

Mr. Bogle's "experiment in human values," as he likes to call it, began in December 1949 as the economics major's senior thesis at Princeton University. Back then, he says he didn't know a stock from a bond, but he did his research on the mutual fund industry and concluded that mutual funds should focus on portfolio management, not marketing; should operate in an "efficient, honest, economical way"; and should cut transaction and management costs as much as possible. Mr. Bogle's thesis will be published this fall, some 50 years later, by McGraw-Hill.

Mr. Bogle created the first index fund in 1974 on the premise that "mutual funds can make no superior claims to the market." In other words, for bonds, no fund manager can outguess interest rates, and for stocks, no manager can outperform the market on a cost-adjusted basis.

In fact, Vanguard funds incur the lowest operating expenses in the mutual fund industry. In 1998, the funds cost on average 0.28% of assets annually, or $2.80 for every $1,000 invested, compared with the average fund expense ratio of 1.25%, or $12.50 for every $1,000 invested.

According to Mr. Bogle, between 1985 and 1999 annual equity returns averaged 18.4%. The average mutual fund returned 17.3% -- BEFORE costs. After transaction costs, expenses, and taxes, the return looked more like 13%. In contrast, the Wilshire 5000 Index Fund -- with no transaction costs, a low expense ratio, and low taxes -- racked up a 17% return for investors. Were it not for survivor bias (600 funds went out of business last year), the mutual fund average would be far lower.

"This industry should be ashamed of itself," Mr. Bogle said of his mutual fund brethren, adding that he would love to see some competition to help keep Vanguard on the cutting edge. But most mutual funds are reluctant to offer competing index funds because "there's no money in taking on Vanguard on Vanguard's field."

In other words, it goes against the mutual fund industry's moneymaking interests to cut fees and marketing expenditures, and offer no-load funds (i.e., funds with no sales commissions). The interests of the mutual fund industry simply are not aligned with the interests of the customers they claim to serve.

In contrast, Vanguard's mission statement is "To provide a broad range of mutual funds and auxiliary services that meets the needs of individual and institutional investors, in accordance with the highest standards of quality and at the lowest reasonable cost."

The Motley Fool has consistently advocated investing in index funds. Step Four of the Fool's "13 Steps to Investing Foolishly" specifically praises index funds as "our first-stop recommendation to investors of all kinds, novice and experienced. Factor in convenience, performance, low expense, and simplicity, and these things beat the pants off the two traditional options, brokers and mutual fund managers."

I can't say enough about the beauty and simplicity of index funds. John Bogle's "experiment in human values" was a great success and a boon, not just for Mr. Bogle and The Vanguard Group, but for all investors.

Related Links:

  • Fool's School
  • The Truth About Mutual Funds
  • Vanguard website
  • Common Sense on Mutual Funds by John Bogle