Partial front page of Wall Street Journal

Investors move to index funds in record numbers

Debate began when Jack Bogle founded Vanguard Group and created the first index mutual fund in 1975. Index funds, often referred to as “passive” funds, seek to track a specific benchmark (the S&P 500 is the most noteworthy example). The index funds have been pitted against “active” funds, where the fund managers buy and sell individual assets in an attempt to generate returns that exceed the overall market as measured by the given benchmark. The indexers argued that active managers cannot consistently generate superior performance and that their costs merely subtract from what investors can earn via an index fund that yields benchmark performance. Most of the academic evidence over the years has confirmed the index fund argument. But the active management premise has remained alluring. It appears though that the pendulum is swinging definitively to the passive approach, certainly for retail investors.

The Wall Street Journal on Monday, January 5, 2015 featured a front page article titled “Investors Shun Stock Pickers”. The continuation page headline read “Vanguard Sets Record Mutual Funds Inflow”. The article provides some very interesting data obtained from Morningstar Inc., the well-respected fund research firm. The key issue has always been cost versus performance. The Journal states that: “Active investments have been hurt by years of subpar performance and high fees.” For 2014 the newspaper reports that according to Morningstar, “Through Dec. 29, about 74% of active stock funds in the U.S. were underperforming their category benchmarks.” The S&P gained about 15.4% during this period and the Vanguard S&P 500 index fund has matched that. The real kicker–“Investors pay 18 cents for every hundred dollars they invest with Vanguard, compared with $1.24 for the average actively managed mutual fund, Morningstar said.” Now you tell me if you want to pay six or seven times as much for subpar performance.