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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.
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.
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.