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How John Bogle Changed the Investing World

In January 2011, events in Tunisia set off a revolution that began to spread rapidly across the Mid-East. In 1973, the publication of Burton Malkiel's A Random Walk Down Wall Street set off a revolution of a different kind. Malkiel presented the findings from academic research on the failure of actively managed funds to beat the market. The standard response at the time was "So what? You can't buy an index fund." That was true until John Bogle came along.

Bogle founded The Vanguard Group in 1974 and started the Vanguard 500 Index Fund (VFINX) (then called the First Index Investment Trust) soon after. The following June, a very prescient story appeared in Fortune: "Index Funds: An Idea Whose Time is Coming." It concluded: "Index funds now threaten to reshape the entire world of money management."

Philosopher Arthur Schopenhauer once said that all great ideas go through three stages:

  • In the first stage, they're ridiculed.
  • In the second stage, they're strongly opposed.
  • In the third stage, they're considered to be self-evident.
This was certainly the case for Bogle's experiment. When it was launched, it was heavily derided by the mutual fund industry. The fund was even described as "un-American," and it inspired a widely circulated poster showing Uncle Sam calling on the world to "Help Stamp Out Index Funds." The fund was lampooned as "Bogle's Folly." Fidelity's Chairman, Edward Johnson, assured the world that Fidelity had no intention of following suit when he stated: "I can't believe that the great mass of investors are going to be satisfied with receiving just average returns." And an executive of fund manager National Securities and Research Corporation derided the notion of settling for average: "Who wants to be operated on by an average surgeon?"

The fund began with comparatively meager assets of $11 million, then finally got to $100 million about six years later. It started to pick up steam, reaching the $500 million mark in 1987, then surpassing $100 billion just 10 years later. Today, the fund has $106 billion of assets, the similar Vanguard Total Stock Market Index Fund (VTSMX) has over $150 billion, its Total Bond Market Index Fund (VBMFX) has almost $90 billion, and its Total International Stock Index Fund (VGTSX) has over $50 billion. In total, Vanguard now has well over $800 billion of indexed assets.

The success of "Bogle's Folly" demonstrates the wisdom of Victor Hugo's statement: "There is one thing stronger than all the armies in the world, and that is an idea whose time has come." One of the great ironies is that Fidelity (with the same chairman, Edward Johnson) is now one of the largest providers of index funds -- if you can't beat them, join them.

The ultimate success of "Bogle's Folly" was virtually inevitable. It was just a matter of time. Holman Jenkins of The Wall Street Journal made the following observations in his December 10, 2003 column "Also Stalking the Fund Industry: Obsolescence."

"Will fund customers keep supporting the enormous overhead required to sustain ineffectual, unproductive stock picking across an array of thousands of individual funds devoted to every 'investing' style and economic sector or regional subgroup that some marketing idiot can dream up? Not likely. A brutal shakeout is coming and one of its revelations will be that stock picking (and sector picking) is a grossly overrated piece of the puzzle, that cost control is what distinguishes a competitive firm from an uncompetitive one."

In 2007, Bogle estimated that the costs of intermediation in financial securities came to a staggering $528 billion, or 3.8 percent of GDP. He noted that was almost exactly the same amount spent that year by all businesses on new factories, office and stores.Were the benefits worth it? Clearly the evidence shows that the main beneficiaries were the intermediaries, not investors.

David Swensen, chief investment officer of the Yale Endowment Fund, offered the following observation. "Thievery, even when dressed in the cloak of SEC-approved governance, remains thievery ... as the powerful financial services industry exploits vulnerable individual investors." When challenged by the Wall Street Journal that his conclusions were "pretty harsh," Swensen replied, "The evidence is there."

As Upton Sinclair noted: "It's amazing how difficult it is for a man to understand something if he's paid a small fortune not to understand it."

More on MoneyWatch:
Book Review: John Bogle's Don't Count on It A Motley Fool and His Money Are Soon Parted What the Dollar's Reserve Currency Status Means for Your Investments Libya Provides Reminder That Stocks Are Risky Quest for Alpha: What You Need to Consider When Handling Your Own Investing
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