By Jason Zweig | Sept. 26, 2017 8:22 p.m. ET
Image credit: “St. George Slaying the Dragon” (Fol. 153v, ca. 1475), Manuscript M.1001, Pierpont Morgan Library
I’m pretty sure this article, from 1995, is the first I ever wrote about Vanguard, although I’d met Jack Bogle at least two years earlier. I’d write it differently today, of course, but I think it still gives a decent feel for what made Vanguard, once the “odd duck of the fund industry,” into a juggernaut. Like all companies that go on to overturn traditional ways of doing business, Vanguard felt then like a cross-pollination between a guerrilla army and a religious cult.
Vanguard: The Penny-Pincher
A low-cost fund from Vanguard is a smart buy for the investor with no illusions about beating the market. Vanguard makes particular sense in fixed-income investing.
Forbes magazine, Aug. 28, 1995
At the $155 billion Vanguard Group., cost-cutting is a religion.
This family’s 79 funds are the lowest-cost choices available, and they dominate Forbes’ Best Buy lists year after year.
Is cost the only consideration? No. It never is for the smart consumer. In our Best Buy rankings of stock funds, we count performance and low cost equally. Among domestic bond fund Best Buys, cost is weighted three times as heavily as performance.
Vanguard has a so-so record in stock funds, but it shines in bond funds, where its low costs give it an advantage competitors are hard-pressed to overcome with fancy trading. Thus the Best Buys Sampler nearby (p. 66) does not even list the numerous Vanguard taxable and tax-free bond fund Best Buys that are detailed on pages 135 and 136.
Even among stock funds, the cheapskate approach does pretty well over long periods. Look at Vanguard Index 500, a $12 billion fund that mechanically replicates the performance of the Standard & Poor’s index of 500 large U.S. stocks. Vanguard charges just 0.2% in annual operating expenses to run this fund.
The average stock fund charges six times as much, and in the past year about one-third of them have beaten the Vanguard Index 500 fund. This means that investors in two-thirds of the stock fund universe are paying higher fees for an inferior product. If you are convinced the guy running a given fund is another Peter Lynch, it’s worth paying to get his services. But if you are not fairly confident your actively managed stock fund will beat the Index 500 fund, why pay more to get it?
Now look at Vanguard GNMA Portfolio, a bond fund that owns paper backed by the Government National Mortgage Association. The annual cost of owning this portfolio is just 0.3% of assets. The average mortgage fund hits customers with fees three times that high. Those charges eat so sharply into returns that GNMA Portfolio has beaten 92% of all mortgage funds over the past decade—not because it is smarter but because it runs a tighter ship. Why pay more, indeed?
Vanguard is the odd duck of the fund industry. Almost alone among the 600 companies that manage mutual funds in the U.S., Vanguard is owned entirely by the shareholders in its own funds. It is modeled after a mutual insurance company, which is owned by its policyholders and run solely for their benefit.
Maybe that’s a bit overstated. You could argue that mutual institutions are also run for the benefit of the executives who draw nice salaries—the soon-to-retire head of Vanguard, John Bogle, has a seven-figure compensation package. Still, he’s not
walking off with a billion dollars’ worth of stock, which he would be if he owned the place.
Bogle, 66, came up with the mutual concept just before founding Vanguard. He says, “Around 1970 I realized if a man from Mars landed and observed the mutual fund industry, he’d think we were nuts. If the goal was to serve the fund shareholders well and to keep the managers from being paid too much, why did we have these teeny-weeny management companies running these big pools of assets? Shouldn’t it be the other way around?” In other words, the people who own the assets should own the company that manages them.
Bogle then ran Wellington Management Co. in Boston, which managed $1.4 billion in funds. In 1974, after a dispute with the management firm’s partners, Bogle was fired but remained a Wellington fund director, and he persuaded his fellow directors to “cut the Gordian knot” that tied the funds so tightly to the management company. Wellington Management Co. would still manage the funds’ money, but only under contract to Vanguard. And Vanguard, not the management company, would administer and eventually distribute the well-known Wellington Fund and any future funds. Each fund shareholder would own a proportionate piece of Vanguard.
In 1976 Bogle introduced the Index 500 fund. Unlike actively managed funds, whose skippers try to beat the market, this fund had the rather un-American idea of settling for the market’s average return-—which, left to their own devices, few investors manage to do. Bogle hoped the fund would raise $50 million in its first year; it barely took in $11 million.
“The problem with the indexing idea,” says Bogie, “”is it runs counter to everyone’s business interests -— money managers, brokers, even you guys in the financial press —- except the investor.”
But the public has finally caught on to the tact that most funds underperform the index, and in June, Index 500)-—which has taken in more than $1 billion this year-—surpassed Windsor as Vanguard’s largest stock fund.
Typically, that provoked Bogle to send a form letter to new customers: “If you have a short-term investment horizon, or if you wish to redeem your holdings on any sign of market weakness, Vanguard Index Trust is not the right investment for you.”
Most fund companies are not in the habit of trying to turn customers away. But, barks Bogle, ”All that matters is what’s good for the investor.”
To competing fund executives. Bogle’s constant lecturing about serving shareholders must sound a bit sanctimonious. But Bogle is right. People pay too much to have their money managed. The industry’s $2.5 trillion in assets throws off $24 billion a year in expense payments (not including sales commissions). What does the public get for that $24 billion? Overall performance that usually doesn’t even match the market’s. It’s a fair statement that at least half of that $24 billion is wasted.
Index funds are economical. They do little trading and require no high-paid temperamental stock-pickers. You will never beat the market in an index fund, but you will never lag it by more than a hair, Vanguard slices and dices the stock and bond market into 15 index funds that match the performance of everything from European stocks to intermediate-term bonds.
Vanguard’s bond funds, both the indexed ones and those like GNMA Portfolio that are actively managed, are consistently good buys. You won’t find risky stuff like emerging-market bond funds here. Nor has Vanguard ever gone in for gimmicky short-term world income funds, adjustable-rate mortgage funds or “government-plus” funds. Its junk fund doesn’t reach for yields by buying really tacky stuff and shows a good yield by keeping expenses down.
In non-index stock funds, the case for Vanguard is less compelling. While several of Vanguard’s 27 actively managed stock funds—Prirnecap, Windsor, U.S. Growth—are excellent, many are mediocre. Unfortunately, both Primecap and Windsor are closed to new investors. Most of its non-index stock funds lag the market over long periods, although, to be fair, most competitors perform far worse. Vanguard’s balanced funds—especially Wellesley and Wellington—balance extremely low risk with relatively attractive returns.
Additional resources:
Books
Definitions of ACTIVE, FEE, INDEX, INDEX FUND, MUTUAL FUND, PORTFOLIO MANAGER, in The Devil’s Financial Dictionary
Chapter Nine, “Investing in Investment Funds,” in The Intelligent Investor
Chapter Five, “Confidence,” in Your Money and Your Brain
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