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The Future Seen

Greg Spears

I WAS WRITING magazine stories back in 1996, recommending stocks and mutual funds. Privately, I worried that readers might think I had some genuine insight—and they might even invest in the ways I suggested.

Propelled by that fear, I favored safe stories, like the best electric utility stocks or the outlook for U.S. savings bonds. I ransacked the library, looking for sure-fire, can’t miss investments. Surprisingly, I found one—something called an index fund.

Twenty-five years ago, indexing wasn’t brand new, but it was still a hard-to-explain novelty. Yet, when I looked at the fund performance tables, my eyes got wide. I read the book by John Bogle again, looking for a flaw—but finding none.

I had to see for myself. I drove from Washington, D.C., to Vanguard Group’s headquarters in Malvern, Pennsylvania. Bogle was CEO when Vanguard opened the first index fund for retail investors in 1976. Two decades later, when I visited the Vanguard campus for the first time, he had just shed the CEO title, but was still a looming presence at the firm.

Bogle had resigned to undergo heart transplant surgery, and his clothes still hung loosely on his frame. “My energy has returned,” he told me. “I’ve never been a pessimist, but I’m more optimistic than ever.”

Bogle had worked relentlessly to realize the vision of his senior year thesis at Princeton. It held that a mutual fund company might maximize sales by minimizing the costs it charged investors. His thrifty imprint was all around us. Motion detectors turned off the lights in unoccupied rooms. There was no executive dining room. Everyone went through the cafeteria line with a tray.

The capstone of Bogle’s less-is-more notion was Vanguard’s 500 Index Fund, which owned all the stocks in the S&P 500 index in proportion to their market value. It captured the index’s return, minus costs. Because the fund was managed mainly by computer, its expenses were puny even then—0.2% a year, or 20 cents for every $100 invested. That was less than one-seventh the average cost of its competitors.

“If you operate at high cost, don’t bother to bring out an index fund,” Bogle said. “Only a fool would buy it.”

As its 500 fund gathered assets, Vanguard used the fund’s economies of scale to whittle down fees still further, which left even more of the returns in the hands of shareholders. Bogle’s recently installed successor as CEO, Jack Brennan, told me that day that this was “a virtuous circle,” as he swirled his right hand around his knee.

I’d asked to see the fund in operation. In the slanting light of the afternoon, a Vanguard press representative and I crossed the Vanguard campus and headed into a windowless trading room. At first, it looked disappointing—just a string of grimy Compaq 486 PCs wired together. There was one keyboard.

Then, it sprang into operation. A young stock trader named Michael Buek was typing with two fingers. He was investing that day’s cash flow—$37.5 million. Within 30 seconds, a list of stocks to buy scrolled up the screen: 12,100 shares of GE, 18,100 shares of Coca-Cola, 11,500 of AT&T. The list ran to 320 names.

He downloaded the order onto a computer disk and walked across the floor. He slipped it into a terminal connected to the floor of the New York Stock Exchange. A warning appeared on the screen: “This Is a Very Large Portfolio—Use Caution.” Buek double-checked a few numbers and punched the order in. The whole process took about three minutes from start to finish.

At inception, Vanguard’s index fund had been met with skepticism. The fund wasn’t trying to beat the market, just ride along with it. As Fidelity Investments Chairman Ned Johnson told the press, “I can’t believe that the great mass of investors are going to be satisfied with just receiving average returns. The name of the game is to be the best.”

Johnson was correct in one respect—it took decades for the great mass of investors to discover indexing. But he was wrong about its returns being average. Index funds beat most fund managers handily over the years. It was a relentless competitor.

Vanguard’s indexing wizard Gus Sauter winnowed down the fund’s costs to nothing. He grew so adept at futures trading and other strategies that he’d recoup all the fund’s slender expenses. The 500 fund would beat the S&P 500 index’s annual return by a fingernail—something theoretically impossible.

Capturing the market’s return at an infinitesimal cost seemed like a sure thing, unless stocks crashed, in which case the 500 fund would suffer along with other stock funds. I told my readers it was like getting a 10-yard head start in a 100-yard dash. Today, I think I was understating the case. It’s more like knowing who would win the Super Bowl for the next 20 years running.

Index funds have beaten 85% of actively managed stock funds over the past 10 years, and 92% over 15 years. Investors have followed, pouring $1.9 trillion into index funds and ETFs since 2010, according to the Investment Company Institute. Today, Vanguard’s S&P 500 Index Fund Admiral Shares charges just 0.04%—a fifth of what it charged in 1996—and the exchange-traded version of the fund is even cheaper.

I recommended an index fund to the magazine’s readers only that one time. As my editor explained, if we endorsed index funds, we’d have nothing to put on next month’s cover.

That answer didn’t sit right with me. Later, when Vanguard contacted me about a job, I accepted. I’d seen the future—and it was going to be huge.

Greg Spears worked as a reporter for the Knight Ridder Washington Bureau and Kiplinger’s Personal Finance magazine. After leaving journalism, he spent 23 years as a senior editor at Vanguard Group on the 401(k) side, where he implored people to save more for retirement. Greg currently teaches behavioral economics at St. Joseph’s University in Philadelphia as an adjunct professor. The subject helps shed light on why so many Americans save less than they might. He is also a Certified Financial Planner certificate holder. Check out Greg’s earlier articles.

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John Freedman
John Freedman
6 months ago

Enjoyed the article and walk down memory lane. I’ve been a Boglehead since around the same time in the mid 1990s – great ride but wish I would have jumped on the bandwagon even earlier. The SPIVA mid year 2021 scorecard shows 94% of stock funds overall lagging their index over the recent 20 year period. The track record seems to get even better over time.

Andrew Forsythe
Andrew Forsythe
6 months ago

Greg, thanks for this. I’m another long time Vanguard client and fan and I enjoyed this bit of its history. Hope you’ll regale us with more “Vanguard stories”.

Mel Turner
Mel Turner
6 months ago

Thanks for sharing a great story about the infancy of Vanguard. I hope you will provide some more insight into how Vanguard developed. I made my first deposit to Vanguard in 1978 and have never looked back. Thank you Mr. Bogle!

Lyndon Zielke
Lyndon Zielke
6 months ago

Could you point me toward the data that says that Index funds have beaten 85% of actively managed stock funds over the past 10 years, and 92% over 15 years? I need this information to show my clients why we primarily use low cost indexing.

Jim Burrows
Jim Burrows
6 months ago
Reply to  Lyndon Zielke

Lyndon, the best source for this information is the SPIVA US Scorecard report put out by S&P Dow Jones Indices. Here’s a link to the Mid-Year 2021 report SPIVA U.S. Mid-Year 2021 Scorecard (spglobal.com)

Greg Spears
Greg Spears
6 months ago
Reply to  Lyndon Zielke

Lyndon, the source I often see cited is Dow Jones Indicies LLC. Here is a link to a CNBC story citing the same percentages that does include a chart with that credit line. Hope this helps, Greg

https://www.cnbc.com/2019/03/15/active-fund-managers-trail-the-sp-500-for-the-ninth-year-in-a-row-in-triumph-for-indexing.html

SanLouisKid
SanLouisKid
6 months ago

Great story on your visit to Vanguard. I did not know you worked for Vanguard at one time. I’m sure you have some interesting stories from working there.

Ocher
Ocher
6 months ago

Thanks for the history lesson Greg. Great perspective on how the industry sells its products and services in ways that do not benefit most investors.

mytimetotravel
mytimetotravel
6 months ago

I’ve been a Vanguard investor for decades, and I have been more than satisfied. Good returns with minimal costs and minimal effort – what’s not to like? Kudos for getting out of the crystal ball business.

Philip Stein
Philip Stein
6 months ago

A recently published book, “Trillions” by Robin Wigglesworth, is a history of indexing from its origins to the present day. Highly recommended.

Greg Spears
Greg Spears
6 months ago
Reply to  Philip Stein

Thanks very much for this recommendation, Philip. I’m adding it to the Christmas wish list.

Mark Royer
Mark Royer
6 months ago

Really good article, Greg. I find it interesting, in light of Ned Johnson’s comments, that Fidelity now offers index funds with zero fees. And the latest reports indicate their growth is in passive funds, not active.

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