With Index Funds, the Winning Continues
By Martin Krikorian
“Don’t look for the needle in the haystack. Just buy the haystack.”
-- John Bogle, founder of Vanguard and inventor of the index fund
Earlier this year, John Bogle passed away at age 89. In 1974 Bogle founded the Vanguard Group, and two years later, he introduced the index mutual fund. The index fund provided a way for the average investor to match the stock markets return at a much lower cost than the high-fee actively managed mutual funds. At the time, the index fund was ridiculed by Wall Street and the Investment Industry. Why would anyone be satisfied with an investment that did not try to outperform the stock market?
During its initial launch, the fund (currently known as the S&P 500 Index Fund) collected only $11 million. Forty-three years later Index funds currently account for approximately $7 trillion of mutual fund assets.
I have stated numerous times in this column over the past 17 years, that I am a big proponent of index funds. At Capital Wealth Management, approximately 75 percent of our clients are invested in index funds. Academic research overwhelmingly points to the superiority of index funds versus actively managed funds. One of the most popular studies comparing the performance of index funds and actively managed funds is SPIVA report. Every year, since 2002 The Standard & Poor’s “S&P Indices Versus Active” (SPIVA) report compares the annual performance of actively managed mutual funds to their index funds.
The report card for 2018 is in, and once again, the grades for actively managed mutual funds were not very good. The accompanying chart shows the percent of actively managed mutual funds that underperformed their corresponding index in 2018, as well as the last 10 and 15 year periods.
One the biggest reasons why index funds outperformed their corresponding asset category of actively-managed mutual funds is that Index funds have much lower expenses. The average actively managed mutual fund has an annual expense ratio of about 1.2 percent. Index funds have an average annual expense ratio of 0.5 percent. Vanguard has index funds with an average expense ratio of just 0.1 percent. This means, that on average, an index fund can begin each year with a 1.1 percent head start on actively-managed funds.
Many investors are under the impression that looking at a fund’s past record or its Morningstar star rating that they can determine which funds are likely to outperform their index. However star rating’s and past performance are not as good a predictor of future performance as a fund’s expenses. Even Morningstar acknowledges that fund expenses are better at predicting future performance than its own ‘star’ rating system.
In an article by Russel Kinnel, Morningstar’s director of mutual fund research, titled “How Expense Ratios and Star Ratings Predwict Success,” Kinnel states; “If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds. Investors should make expense ratios a primary test in fund selection. They are still the most dependable predictor of performance.”
Martin Krikorian is president of Capital Wealth Management, a registered investment adviser providing “fee-only” investment management services located at 9 Billerica Road, Chelmsford. He is the author of the investment books, “10 Chapters to Having a Successful Investment Portfolio” and the “7 Steps to Becoming a Successful Investor.”
Martin can be reached at 978-244-9254, Capital Wealth Management’s website, www.capitalwealthmngt.com , or via email at, firstname.lastname@example.org .