Bogleheads® 2022 Conference – Bogleheads University – Principle 6: Use Index Funds When Possible
00:00:00.000 | [APPLAUSE]
00:00:06.900 | Which brings us to number six.
00:00:11.480 | How am I doing?
00:00:12.120 | Good?
00:00:13.200 | Good, thanks.
00:00:14.240 | Number six, use index funds when possible.
00:00:18.480 | Why when possible?
00:00:20.400 | Because it's not always possible.
00:00:23.280 | I mean, there are people, I'm sure, in this room who
00:00:25.880 | belong to a 403(b) plan of some sort,
00:00:29.200 | and it's a horrendous plan.
00:00:31.120 | And all they have is actively managed funds.
00:00:33.720 | And you can't get an index fund.
00:00:35.280 | Or maybe there's just one index fund available,
00:00:37.640 | and it's an S&P 500 fund, perhaps.
00:00:40.080 | So when possible, though, use index funds.
00:00:43.640 | And I'm going to explain why.
00:00:45.560 | First, before I do that, I have to explain
00:00:48.080 | what an index fund is.
00:00:50.280 | So this is how I like to explain.
00:00:53.240 | Again, I'm using pictures.
00:00:55.600 | On the left side, you have companies--
00:00:58.240 | Exxon, Apple, Home Depot, Google, whatever,
00:01:01.920 | hundreds of them.
00:01:02.640 | In fact, there are 4,200 companies in the United States.
00:01:06.440 | But these companies are publicly traded.
00:01:09.960 | They're publicly traded on a stock market, daily.
00:01:13.240 | Google trades, Apple trades, all these stocks
00:01:15.480 | are trading on a daily basis.
00:01:17.160 | Well, there are companies, such as Standard & Poor's,
00:01:19.360 | who keep track of all this trading,
00:01:20.960 | keep track of all these prices.
00:01:23.120 | And the big companies will weigh more in their index
00:01:27.320 | than the smaller companies or the tiny companies.
00:01:30.720 | So indexes are what's called capitalization weighting.
00:01:33.960 | The big companies have a much bigger weighting.
00:01:36.960 | And then the smaller companies have a much smaller weighting.
00:01:39.500 | So you get this tier down here.
00:01:41.920 | So obviously, Apple, Home Depot, Google, and so on,
00:01:46.400 | these are big weightings in the S&P 500.
00:01:49.880 | But they keep track of that.
00:01:51.080 | Because this is the capitalization weight
00:01:53.560 | of the stock market.
00:01:55.040 | So it is the investable universe.
00:01:58.600 | If you had money to invest in the market
00:02:02.680 | and you were looking for stocks to invest in,
00:02:05.240 | you'd go to the S&P 500 or go to the total stock market, which
00:02:08.340 | has 4,200.
00:02:09.920 | And it's the investable universe by market capitalization.
00:02:14.540 | Now, what companies like Vanguard did--
00:02:17.800 | and Vanguard did this, Jack Bogle did this back in 1976--
00:02:22.320 | they went to Standard & Poor's.
00:02:25.000 | And they said, we want to license your index.
00:02:28.640 | And Standard & Poor's David Blitzer,
00:02:31.000 | who happened to be the head of the index committee
00:02:33.680 | at the time, remembered the conversation.
00:02:35.460 | In fact, I did a podcast with David.
00:02:37.080 | And he remembered this conversation.
00:02:38.720 | He said, why would you want to do that?
00:02:41.200 | You want to create an index fund?
00:02:43.080 | And Vanguard, Jack Bogle said, yes.
00:02:45.600 | How much would you charge us to create an S&P 500 index fund?
00:02:49.720 | And S&P didn't know what the answer was.
00:02:52.480 | So they agreed on $25,000 was the fit.
00:02:57.080 | Well, little did they know what would happen next, right?
00:03:01.040 | Vanguard creates the Vanguard 500.
00:03:03.080 | At the time, it wasn't called the Vanguard 500.
00:03:05.080 | But they created that index fund.
00:03:06.460 | And they launched it out.
00:03:08.080 | Now, it took 10 years before that fund
00:03:10.000 | got a billion dollars in it.
00:03:11.400 | But as it grew and as S&P realized
00:03:14.480 | that this is really something, indexing,
00:03:18.560 | that they went back to Vanguard.
00:03:20.560 | And they renegotiated the contract.
00:03:22.200 | And a few years later, Vanguard actually left S&P
00:03:24.940 | and went to MSCI.
00:03:26.360 | And now they're at CRISP because S&P
00:03:28.360 | was charging too much money.
00:03:29.520 | There's nobody here from S&P. But I can say that.
00:03:31.820 | So I know the inside story.
00:03:33.200 | Anyway, so there's a big competitive market out there
00:03:35.440 | for these indexes.
00:03:36.280 | But this is an index.
00:03:37.240 | So you end up with an S&P 500, which
00:03:39.080 | tracks those 500 stocks, which are tracking
00:03:41.360 | the big stocks on the stock exchange, which those companies
00:03:43.760 | actually exist.
00:03:44.860 | And that's how they capitalize themselves.
00:03:46.840 | So that's an index.
00:03:48.080 | S&P 500 is just an example.
00:03:50.160 | Total market would be all 4,200.
00:03:52.760 | Then there are international stocks, same thing.
00:03:55.360 | 6,500 or so stocks traded outside the US.
00:03:59.040 | Index is created the same way.
00:04:00.640 | And there are bonds, bond indices, treasury bonds,
00:04:04.200 | corporate bonds, mortgages, all put together
00:04:06.680 | into the Bloomberg Aggregate Corporate Bond Index.
00:04:11.880 | And I did a podcast with the people who run the index
00:04:15.560 | and also the people at Vanguard who run that fund.
00:04:18.720 | And it's really interesting to talk to the two.
00:04:20.680 | So there's all the indexes out there all over the place
00:04:23.280 | covering all kinds of asset classes.
00:04:24.960 | And you have a choice now.
00:04:27.200 | You didn't have it 45 years ago.
00:04:29.400 | But you have it now.
00:04:30.720 | You can either buy an index fund that tracks those indices,
00:04:38.480 | and it's at a very low fee.
00:04:40.440 | Or you can do the kind of the traditional thing
00:04:45.320 | 50 years ago, 40 years ago, which
00:04:47.480 | is to try to pick a money manager or a mutual fund that
00:04:51.960 | is actively managed that's going to beat that index.
00:04:55.600 | So large cap US stock manager who's
00:04:58.720 | going to go out and try to beat the S&P 500.
00:05:02.160 | So you can either-- that's active management.
00:05:05.400 | And you can do this in international stocks and bonds
00:05:07.800 | and so forth.
00:05:09.240 | Now, here's the kicker.
00:05:10.560 | What has happened since Jack Bogle and Vanguard
00:05:13.760 | created the first index fund?
00:05:15.520 | And index funds have proliferated
00:05:17.120 | into all these other asset classes.
00:05:19.480 | My very first podcast was with Jack Bogle.
00:05:21.800 | And we talked about this.
00:05:22.840 | By 1996, Vanguard had a total stock market index fund,
00:05:26.520 | a total international stock index fund, a total bond market
00:05:30.680 | index fund.
00:05:31.640 | And it had a REIT index fund, Real Estate Investment Trust.
00:05:35.080 | So pretty much had the four core four type portfolio of index
00:05:39.240 | funds, all available at Vanguard, all low cost.
00:05:42.080 | And how have those funds performed
00:05:45.480 | relative to the actively managed funds that were
00:05:48.320 | trying to beat those indices?
00:05:49.920 | Well, let's take a look.
00:05:52.520 | This is what's called the SPIVA.
00:05:53.800 | Now, my last podcast I just did was with Craig Lazara
00:05:57.800 | from Standard & Poor's Indices, Standard & Poor's Dow Jones
00:06:01.440 | Indices, because they merged.
00:06:03.280 | And what this shows-- this is just looking at one segment.
00:06:07.320 | This is the S&P 500 index versus the managers who are
00:06:12.480 | trying to outperform the index.
00:06:15.440 | Those numbers, large cap fund up on top,
00:06:18.760 | and then mid cap fund, which is a mid cap
00:06:21.400 | indice, and the bottom, which is an S&P small cap.
00:06:24.520 | After one year, 55%--
00:06:30.680 | let's read in the top line, skip year to date
00:06:32.840 | and just go to one year--
00:06:33.920 | 55% of the active managers underperformed the S&P 500.
00:06:40.560 | If we go out further and we look at five years--
00:06:44.400 | and these are the managers who survived,
00:06:46.720 | because so many actively managed funds just go under.
00:06:50.600 | They go out of business.
00:06:52.680 | The mutual fund companies won't tell you this.
00:06:54.880 | When you look at the mutual fund advertising,
00:06:56.520 | they're going to advertise all the funds that survived
00:06:58.800 | and actually did well.
00:06:59.720 | They're not going to show you the other half that
00:07:01.760 | all went out of business.
00:07:02.760 | They're not going to show you those.
00:07:04.260 | So over a five year period of time, of the funds that
00:07:06.840 | actually made it five years, 84% underperformed the S&P 500.
00:07:14.320 | If you go out 20 years, 95% of all actively managed large cap
00:07:19.960 | mutual funds that were trying to beat the market
00:07:22.360 | underperformed the S&P 500.
00:07:25.360 | And if we go to the mid cap, which are smaller companies,
00:07:27.960 | but not small cap, tiny companies, we go to the right.
00:07:31.880 | And look at that.
00:07:32.640 | 94% over a 20 year period of time of the active managers
00:07:37.960 | in the mid cap sector of the market
00:07:41.440 | underperformed the mid cap index.
00:07:43.620 | And let's go a little further to the small cap funds, which
00:07:45.920 | are the small companies.
00:07:47.960 | And we'll use the S&P 600 small cap index.
00:07:51.560 | 94% of the active managers who attempted
00:07:54.200 | to outperform the small cap index underperformed it.
00:07:59.440 | All right.
00:08:00.840 | Now, am I going to spend my money
00:08:05.100 | trying to pick the 5%?
00:08:07.600 | No.
00:08:08.640 | I can be in the top 95% tile over a 20 year period of time
00:08:14.080 | just by buying an index fund.
00:08:16.080 | And I know that there are going to be a few active managers
00:08:19.160 | out there.
00:08:19.680 | And all these asset classes across the globe,
00:08:23.260 | there's going to be a few that do outperform.
00:08:25.140 | But we don't know who they are today.
00:08:28.360 | And is it worth going after these managers?
00:08:30.640 | And the answer is no, it isn't.
00:08:32.720 | If we look at why this occurs, the answer is very simple.
00:08:36.840 | And Alan Walters is going to get to this in more detail
00:08:39.600 | in the next session.
00:08:40.640 | It has to do with fees.
00:08:43.680 | Almost 100% having to do with fees.
00:08:45.960 | And then it has to do with managers turnover
00:08:48.040 | and have to do with funds get too much money
00:08:49.840 | and they can't invest the way they used to invest.
00:08:51.920 | There are a few other things.
00:08:53.180 | But I think, Alan, when you see his presentation,
00:08:55.280 | he's going to talk a lot more about fees.
00:08:57.200 | So index funds have very low fees.
00:09:00.740 | Active managers cost money.
00:09:01.960 | They have all these research analysts
00:09:03.540 | and everybody else they have to hire.
00:09:05.080 | It's more money.
00:09:06.180 | So generally, the low cost of the index funds
00:09:09.260 | is the reason over the very long term
00:09:11.500 | that the index funds float to the top
00:09:13.860 | and get into the top 90%, 95% tile.
00:09:17.340 | And this not only happens in the United States.
00:09:20.460 | It happens internationally.
00:09:21.700 | It happens in bonds.
00:09:22.740 | It pretty much happens everywhere.
00:09:24.260 | And I don't want to get into the details too much.
00:09:26.300 | But if you look at the SPIVA scorecard or the Vanguard
00:09:29.140 | studies that they do every year, Morningstar does studies
00:09:32.260 | on this every single year.
00:09:33.420 | The proliferation of the studies,
00:09:35.080 | there's a lot of them out there right now.
00:09:36.460 | 20 years ago, they weren't out there.
00:09:38.140 | You had to dig it up.
00:09:38.640 | When Jack Bogle first created the index fund in 1996,
00:09:41.060 | he had to, by hand, by hand, go back and pull out
00:09:45.060 | all the performance of each of the individual index actively
00:09:48.280 | managed funds and put together his own database because there
00:09:50.820 | was no Morningstar out there at that time.
00:09:53.380 | Nobody was collecting this data.
00:09:54.980 | This data really wasn't prevalent until around 1997
00:10:00.420 | when Mark Carhart from the University of Chicago
00:10:02.420 | actually put together the first comprehensive survivorship
00:10:05.940 | bias-free database.
00:10:07.380 | And then now we see that, hey, most active managers
00:10:12.160 | don't outperform the market.
00:10:14.540 | Most will underperform.
00:10:16.140 | So what do you do?
00:10:18.460 | What do I do?
00:10:19.060 | What do I believe?
00:10:20.580 | I did a study 10 years ago now that was published.
00:10:23.500 | I said if all you did was buy index funds in every asset
00:10:27.700 | class, however many asset classes you want--
00:10:30.140 | this is the three-fund portfolio,
00:10:31.860 | which is the total stock market, US,
00:10:34.300 | the total international stock market,
00:10:36.660 | and just a total bond fund.
00:10:39.180 | If this is all you did, just bought a few good low-cost
00:10:43.140 | index funds in the asset classes that you want,
00:10:46.540 | you will be in the 90th percentile of all investors.
00:10:50.780 | You're going to be at the top 10%.
00:10:53.420 | Will you be number one?
00:10:54.780 | No.
00:10:56.020 | I don't have to be number one.
00:10:57.300 | I mean, I'm a good pickleball player.
00:10:59.100 | Really?
00:10:59.860 | I think I am.
00:11:00.460 | But am I number one?
00:11:01.660 | No.
00:11:02.460 | That's OK.
00:11:03.660 | I could be in the 95th percentile.
00:11:05.100 | I'll be happy with that.
00:11:06.020 | And I think the same way with our portfolios.
00:11:07.980 | We try to outperform.
00:11:09.940 | Odds are, high chance you're going to underperform.
00:11:13.220 | It's going to cost you more money.
00:11:14.860 | And we're not even getting into the taxes of the turnover
00:11:17.340 | of going from this fund to that fund to this fund.
00:11:19.420 | So this is why we say at the Bogleheads,
00:11:21.940 | use index funds when they're available.
00:11:24.700 | Use them in every single asset class.
00:11:26.660 | Don't worry about anything else.
00:11:28.660 | Just invest in a few good index funds.
00:11:32.100 | And that's it for me.
00:11:35.180 | you
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