A Hollow Victory?

Jonathan Clements

VANGUARD GROUP founder John C. Bogle has an article in the latest Financial Analysts Journal where he reviews the growth of index funds over the 40 years since the launch of Vanguard’s first index mutual fund—and where he makes pointed remarks about their upstart cousins, exchange-traded index funds.

First, consider the phenomenal growth of index funds. They surged from 4% of stock fund assets in 1995 to 16% in 2005, and then kept barreling right along, hitting 34% in 2015. Much of the recent growth has come not from the traditional no-load index funds, but from exchange-traded index funds, or ETFs. You can buy a no-load index fund directly from the fund company involved, with your purchase price established as of the 4 pm ET market close. By contrast, to buy an ETF, you need to open a brokerage account and trade the stock market-listed shares.

Either way, the smart strategy is to buy and hold. That way, you collect the market’s performance, while incurring minimal investment costs. True, you won’t beat the market averages. But you will beat your neighbors, who are aiming for superior returns but almost always end up with far less, as their results are dragged by high trading costs and the hefty fees charged by actively managed funds.

Problem is, ETFs aren’t used to buy and hold. In 2015’s first nine months, the 100 largest ETFs, valued at $1.5 trillion, were traded at an annualized turnover rate of 864%. As Bogle writes, ETFs seem “designed to provide a new way for institutional and individual short-term speculators to trade to their hearts’ content—and thus a new opportunity for Wall Street to make profits from index funds.” In short, index funds may have triumphed, but it’s far from clear that smart money management has prevailed.

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