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Recently, I have been speaking with more and more people about dumping their mutual funds and individuals stocks. Instead, I encourage them to move towards low-cost passive index funds. The investors that I talk to love the low-cost fee structure of index investing, as well as the built-in diversification. Most people praise the work that Vanguard has done. In fact, Vanguard has become synonymous with the low-cost fee model.
A common concern I hear is if it is actually possible to make large investment gains by simply investing in index funds like the S&P 500. That just seems too simple to yield great results.
Before I address this, let’s first look at how it all began.
On August 31st, 1976, John C. Bogle created the first ever S&P 500 index fund, called the First Index Investment Trust, by the Vanguard Group. Thus, passive index funds have been around for over 40 years now. However, this idea had been permeating in Bogle’s mind as early as 1949, while determining his senior thesis while he was at Princeton.
While searching for topics to research, he stumbled upon an article in Fortune magazine (December 1949) called “Big Money in Boston“. The article described the mutual fund industry.
His Findings
In his research, he discovered that the mutual fund industry’s growth could be maximized if firms concentrated on a:
- “Reduction of sales loads and management fees”
- “Fund investment objectives must be stated explicitly”
Meanwhile the mutual funds firms should try:
- To avoid creating “the expectations of miracles from management”
- To “make no claim for superiority over the market averages”
As most of us know, most major mutual funds today still struggle to reduce fees. Instead, they tout their star managers and try to sell prospective customers on their past performance compared to the market.
While that may have worked in the past, investors are becoming smarter by the day. Information is at most of our fingertips. As a result, there has been a trend towards passive index funds. In fact, in 2017 alone, $692 billion flowed into passive index funds, while $7 billion flowed out of mutual funds, continuing the hemorrhaging that active management funds have felt since 2013.
As of today, Vanguard manages more than $4.5 trillion in assets. That makes it the largest mutual fund company in the world.
For those who haven’t read it, I recommend the classic, John Bogle on Investing: The First 50 Years, to understand the entire history of Vanguard by the man who revolutionized the industry himself.
This book has it all. It includes his early struggles, the people that doubted him, and his drive to stay the course to create the largest mutual fund company in the world, despite being ignored and even loathed by those in the mutual fund industry.
S&P 500
Okay, now that we have gone through a quick history lesson, let’s make sure we are on the same page about the S&P 500.
The S&P 500 index fund is an investment vehicle, that invests in 505 stocks, (5 of the companies are comprised of multiple classes of shares Comcast, News Corp, 21st Century Fox, Google and Discovery Communications), in market cap-weighted proportions. For those of you wondering, even though Berkshire Hathaway has two classes of shares, only the “B” shares are counted, since the “A” shares barely trade as the average volume is 400 shares a day.
Speaking of Warren Buffett, he says that the S&P 500 index fund is the best investment the average American investor can make today. When he passes away, he has stated that all of his wife’s investments should be in the Vanguard 500.
How much would investing $10,000 into the S&P 500 in 1976 be worth today?
Since 1976, the S&P 500 index has generated a total return of approximately 8,182% as of today. This translates to a 11.23% annualized rate of return with dividends.
Making the assumption of an expense ratio of 0.2% on your index fund, which has steadily been going down over the years, this means that a $10,000 investment would have turned into just over $800,000 as of March 1, 2018.
It’s no wonder that Warren Buffett is a huge fan of the Vanguard 500. It’s also no wonder why he advocates for simply setting up an account along with automatic deposits for the average American.
That just goes to show you that sometimes simplicity can outperform active managers over time.
Hi Rob, I was just researching yesterday when the first index fund was started. So, I am not surprised, but I also didn’t know until I looked it up. I was researching and writing about a little investing history myself. Tom
Tom @ Dividends Diversify recently posted…The Dividend Deep Dive
Thanks for sharing Tom!!! I’ll have to check out your article 🙂
I have heard so many great things about S&P 500, especially from Dave Ramsey. The only stock related investment we have right now is our 401k.
We are trying to pay off our house like you did. Once we do, I will definitely look into index funds.
Ms. Frugal Asian Finance recently posted…3 Things I Waste Time & Money On
Thanks for sharing Ms. FAF!!! Paying off your house is a great goal. Can’t wait to hear when you pay off the house!!!
Historical evidence is so solid. After reading about it, everyone should be using this passive approach and getting more sleep at night since their portfolio is well diversified too. I hope I can find an audio version of this book at the library! 🙂
SMM recently posted…Practical Advice From The Famous And Wealthy
It’s a really great book!!! You will really enjoy listening to it!!!
I’m currently reading JL Collins ‘A Simple Path to Wealth’ and he really advocates Vanguard because of what you mentioned about their low cost fees. And with the strategy of investing in passive index funds, it shows that anybody can do it even the ones who are not interested in investing but want to have their finances in tact, they should go to that route.
Kris recently posted…Developmental Checklist for Our Two Year Old
JL Collins is amazing!!! His stock series is wonderful and a must read if you’re interested in investing in the stock market 😉
“In fact, in 2017 alone, $692 billion flowed into passive index funds, while $7 billion flowed out of mutual funds…”
I’ve not heard those numbers before. Doesn’t that undercut your argument? The US Mutual Fund market is around $17 Trillion. The US ETF market is around $3 Trillion. The $7 billion out of mutual funds is $0.007 Trillion or less than 0.1%. Furthermore, the size difference between $692 and $7 indicates people are funding ETFs from a lot of other sources than mutual funds outflows. $7 Billion outflow from a $17 Trillion market doesn’t seem significant.
For Mrs. FAF – I’m not a Ramsey fan. He probably advocates paying off your mortgage before investing in the stock market. I would argue it depends on your mortgage rate. If you have a low rate, you are likely better off paying the minimum on your mortgage and investing the rest into a S&P 500 Index ETF. If you have a 30 year mortgage fixed at 3% and the stock market had an “11.23% annualized rate of return with dividends” since 1976, it is clear that borrowing at 3% to buy an asset returning 11.23% is economic. Even if you subscribe to the idea that “the future will not be as good as the past”, you could knock a quarter off 11.23% or ~2.9%. That comes out to 8.3% annualized. Of course, I don’t know if you have a 3% 30 year fixed but you get the idea.
Great points as always Dan!!! I need to do more research on the subject but I think a lot of the mutual funds are due to 401k plans. It’ll be interesting if my theory is correct or not. If so, I could see mutual funds losing more clout as companies wise up. But I’ll read up and provide a better answer 🙂
Yes, I’m an index fund fan as well, even though our UK index the FTSE hasn’t been as good as the S&P500.
Ms ZiYou recently posted…Sunday Short #1 – Privilege
I have to admit I don’t follow foreign markets nearly as closely. That stinks that the FTSE doesn’t have a good of a return as the S&P 500. Hopefully they do better in the future 🙂
Great post, I am also a big fan of the S&P 500 buying into index funds. I have a long term view and also throw a couple of other ones in there for diversification like VXUS or MGK, but overall the S&P500 covers most bases with a good dividend yield.
I love the S&P 500 and it hits all the marks for me but I get why others like to spread around more for diversification sake 🙂
Since reading common sense on mutual funds, I have been a fan of John Bogle. IMO, index funds are one of the greatest advancements in the investing world for the last century. You can save on fees while still making market returns, something that cannot be said for a majority of actively managed funds.
Enoch@SavvyNewCanadians recently posted…How to Spring Clean Your Finances in 2018
Yeah, I think actively managed funds are having their day of reckoning which has long been coming. I look forward to seeing who actually survives.
Based on another research that I came across, over a period of any 20 consecutive years, the S&P 500 had never lost any money. Hence, you can lose if you stayed in the market for 20 Years. I am more than willing to put all my money in the S&P 500 index.
Leo T. Ly @ isaved5k.com recently posted…How I Earned More Money And Pay Less Income Taxes Than My Spouse
Wow I wasn’t aware that over 20 years it’s never lost money. That’s an awesome statistic and one that I will definitely reference. Thanks for sharing!!!