Your Portfolio’s Beating Heart: The Index Fund

Investing is as complicated as we choose to make it. And investors seem to veer in the direction of complexity in their eternal pursuit of ever higher returns.

Why Complicate Things?

As a younger man, I fell victim to that pursuit, too, and it took several years to find my way out of the forest. Like so many young folks who achieve a bit of success, who now have a few extra dollars to invest, and who credit themselves with investment skills not yet learned or that simply don’t exist, it seems to be part of the maturation process. It doesn’t have to be. The hard part of saving and investing is the saving part. But for the moment, let’s talk about the investing part.

Luck…Or A Plan?

There’s a good bit of luck involved in playing the stock market game. Regardless of the amount of time spent researching, it’s very difficult to predict the future variables that affect even a “can’t miss” stock. In my own case, after years of being both right and wrong judging (guessing) market moves, a very cursory study of my success as an investor became self-evident. On balance, to put it kindly, I was barely breaking even. Not being totally muleheaded, I stopped researching individual stocks and started searching for a better investment strategy. One soon caught my eye – a controversial and somewhat revolutionary new product: THE INDEX FUND

Bogle: The Small Investor’s Friend

John Bogle, iconic founder of The Vanguard Group in 1974, created the first credible index fund available to the general public. It roared to an most inauspicious beginning. According to Bogle, the fund’s initial public offering (IPO) in August 1976 “may have been the worst underwriting in Wall Street history”. The IPO’s initial target was $250 million. It fell short of that goal by roughly 95%, and for the next decade, struggled for attention. Its results seemed to be attracting more criticism than new investors, but Bogle, being a patient man, believed that the concept could not be long ignored.

Daring To Be Average

Still, a strategy of simply tracking the broad market was almost totally rejected as an investment plan and quickly became known as “Bogle’s folly”. Fidelity’s Edward Johnson scoffed at the thought that most investors would be satisfied with receiving average market returns (I call it "Dare to be Average") on their fund investments. Bogle’s feeling was the exact opposite, that index funds could provide investors, large and small, with the most effective stock market strategy of all time.

In his mind, the strength of the S&P 500 Index investment strategy was to buy a broad stake in American business and hold it forever. And because it was a passive investment requiring little management, it could be held long-term at a very low cost. In short, index fund owners would become that rarity among investors – long-term owners of stock, a valuable counterweight to the prevailing view of most market participants. And that this countervailing market force could be enormously important to small investors as well as to society in general.

John and George

In my mind (an oil industry graduate), John Bogle (who died January 16, 2019) was the personal investment industry’s George Mitchell. To those not familiar with George, he was Mitchell Energy’s CEO – a long-time wildcatter whose tenacity reordered the world’s energy dynamic by insisting that crude oil and natural gas entrained in rock could, indeed, be economically recovered. Every time you pull into a gas station, you should thank George for his stubborn streak. And every time you check your Roth IRA balance, thank John Bogle for his own brand of stubbornness.

Bogle, like Mitchell, was a man of vision who thought outside the box. Those studies I mentioned earlier kept revealing an unsettling result to the staid investment industry’s active manager proponents. Low-cost funds kept winning the “yield war”, which began to dispel the collective Wazoos’ notion that investors must pay more to get more…the antithesis of Bogle’s notion “that investors as a group not only don’t get what they pay for, they get precisely what they don’t pay for.” Without question, part of the out-performance of index funds is directly attributable to their lower operating expense ratios. In short, indexing’s low-cost effect means the investor keeps more of what his or her fund earns.

According to Vanguard studies, from 1976 to 2016, indexing saved investors close to $153 billion!

Believe The Numbers

It’s true that 20 percent or so of the managed (active) funds outperform index (passive) funds on an annual basis, but it’s seldom the same 20 percent!

Today, broad market index funds modeled on the original Vanguard fund rule the roost, a general recognition that Dare to be Average has become a more commonly accepted practice among small savers in the investment community. This is why it plays such an outsized and important role in this blog’s strategic model.

I’m not suggesting that you invest exclusively in Index funds. I am suggesting, however, that small investors new to the game use an index fund strategy around which to build a portfolio based on those PDQ Principles – Patience,Diversification and Quality – that I talk so much about. And keep it simple.