VANGUARD EFFECT: John Bogle was a ‘capitalist for the common man’

It has been a week since John Bogle, the founder of Vanguard, passed away at the young age of 98. His legacy, despite some odd public policy positions that defy the free market capitalist approach, will be remembered as a “capitalist for the common man.”

Thanks to his low-cost, index-based investment tools, the average person gained access to the stock market without having to spend a fortune on fees and actively monitoring exchanges to find an Amazon, Facebook, or PayPal.

Overall, his passive investing strategy typically beat active trading. If you’re someone with a wife, three kids, a mortgage, a 45-hour-a-week job, and little time to do anything, then mutual funds are for you.

Bogle discussed the so-called Vanguard effect with Bloomberg in 2016:

Imagine a circle representing 100% of the U.S. stock market, with each stock in there by its market weight. Then take out 30% of that circle. Those stocks are owned by people who index directly through index funds. The remaining 70% are owned by people who index collectively. By definition, they own the exact same portfolio as the indexers do in aggregate, so they will capture the same gross return as the direct indexers. But by trading back and forth, trying to beat one another, they will inevitably lose by the amount of their transaction costs, the amount of the advisory fees they pay, and the amount of all those mutual fund management costs they incur: marketing costs, processing, technology investments, everything. When we look at the big picture of the costs of investing, including sales loads as well as expense ratios and cash drag, it is a foregone conclusion that active investors, in aggregate, will under-perform index investors. It’s the mathematics.

It’s the relentless rules of humble arithmetic. The 30% of investors who own index funds capture almost all of the market’s return. In a 7% return market, indexing should deliver approximately 6.95% to investors. (A typical Vanguard all-market index fund charges 0.05%.) The remainder—those who are trading back and forth, hiring managers, and all that kind of thing—will incur costs, in round numbers, of about 2% per year. So, the indexers are going to capture pretty close to a 7% return in a 7% market, while the active investors, who also collectively own the index, are getting the same 7% gross return minus about 2% for all those fees and costs, a net return of 5%. It is definitional tautology that the indexers win and the traders lose.

The stock market is a derivative of the value of corporate America. The intrinsic value of a corporation can be estimated by the dividend yield when you purchase the stock and the subsequent earnings growth. It is corporate America that creates value; the stock market itself creates none. In fact, the stock market subtracts value, due to all the costs we pay to play the game.

Even with his political stances, we should celebrate his life for the fact that he saved everyone $1 trillion!

(H/T AEI)