Live actively, invest passively. A “Pearl of Wisdom” from the book The Boglehead’s Guide to Retirement Planning
- Deadheads: Fans of the rock band The Grateful Dead. They can be recognized by their tie-dye T-shirts and Birkenstock sandals. Their preferred mode of transportation is a vintage Volkswagen Bus which they travel the country in following the band.
- Cheeseheads: Fans of the Green Bay Packers of the National Football League. Distinguishing characteristics include green and gold Packers Jerseys and large, yellow hats shaped like wedges of cheddar cheese. Their favorite mode of transportation is a pick-up truck which they drive to Lambeau Field on Sundays to watch their team play on the famous “frozen tundra.”
- Parrotheads: Fans of the singer Jimmy Buffett. The official Parrothead uniform is shorts, flip-flops, and colorful Hawaiian shirts. A hat shaped like a parrot is a dead give-away. They enjoy riding beach cruiser bicycles while sing Margaritaville.
- Bogleheads: Fans of investing in index funds as popularized by Vanguard founder John Bogle. Bogleheads are known for their successful investing results with a minimum of time and effort.
I am indifferent, at best, towards The Grateful Dead.
I have a lot of respect for the history and tradition of the Packers. The fact they have been able to thrive in the NFL as the smallest of small-market teams is impressive but I am not even a fan of the Packers, let alone a Cheesehead.
Much to my wife’s chagrin, I actually like Jimmy Buffett a lot. Fruitcakes is one of my favorite CDs ever and I used to sing the sweet father-daughter ballad “Delaney Talks to Statues” to each of my three daughters at bedtime. However, I have never had the opportunity to attend a Buffett concert and I don’t even own a Hawaiian shirt, which I think are minimum requirements to be accepted into the “Parrothead” club.
When it comes to investing, I am most definitely a “Boglehead.” I don’t have an official membership card or anything but I have been investing for many years using the principles taught by John Bogle and I have been very pleased with the results. I am convinced that just about everyone would be better off using the principles taught by Bogle as the foundation of their investment program.
John Bogle, Vanguard, and the First Index Fund
Prior to 1976 all mutual funds were “actively managed.” This means that the funds hired investment analysts to do research in an effort to identify the best investment opportunities. The fund manager would then take this information and buy and sell stocks for the fund. It was accepted wisdom that this was the best way to maximize the results of a mutual fund.
John C. Bogle founded Vanguard Mutual Funds in 1974. He immediately started looking for a new approach to distinguish the fledgling company from the industry leaders. As part of this effort Bogle calculated, by hand, the average annual returns for all major mutual funds over the previous 30 years (a daunting task but still possible in the 1970s). He was surprised to find that the return on the average fund was 1.4 percent less than the return on the S&P 500 stock index over the same period. Most actively managed funds were not adding value for their investors.
Bogle describes what happened next. “As I mused about the reasons for the difference, the obvious occurred to me. The index was cost-free, and its 1.4 percent annual advantage in returns roughly approximated the total costs then incurred by the average fund…”
The light bulb came on in Bogle’s mind. He suddenly realized that if he could simply match the S&P 500, while at the same time keeping costs low, he could beat the vast majority of actively managed funds. Buying all of the stocks in an index would allow a fund to match the index while at the same time eliminating the need for expensive research.
Bogle compares this investing approach to the old proverb about looking for needles in haystacks. Looking for a needle in a haystack is both expensive and time consuming, and there is no guarantee you will find the needle. Bogle’s theory was that you would get better results by not looking for the needle and simply buying the haystack. Actively managed funds look for needles, passively managed index funds buy haystacks.
Bogle next examined the effect of this 1.4 percent underperformance of the average fund compared to the S&P 500 index over the 30 years he was studying. He calculated that $1 million invested in the average mutual fund in 1945 would have been worth about $12 million in 1975. Astoundingly, $1 million invested in the index, if it had been possible, would have been worth $18 million.
Armed with this evidence Bogle received permission from the Vanguard board of directors to start the first publically available index fund. The “Vanguard First Index Investment Trust” (later changed to the “Vanguard 500 Index Fund”) officially launched on August 31, 1976. Investing would never be the same.
Bogle’s Folly Becomes Bogle’s Triumph
H.L. Mencken once said, “It is difficult to get a man to understand something when his income depends on him not understanding it.” Bogle’s new idea, the wisdom of which seemed “obvious” to him, challenged the conventional investment wisdom that a lot of people depended on for their income, and thus it became the source of much opposition. The fund got off to a rocky start and was quickly given the nickname “Bolgle’s Folly.” It was also called “un-American.”
The fund grew slowly at first but picked up momentum as it started performing even better than Bogle had predicted. It took a couple of decades but eventually other fund families had to copy Bogle and start their own index funds. Today 7 out of the largest 10 mutual funds are index funds, and 6 out of the 7 are managed by Vanguard. Bogle’s folly has definitely become Bogle’s triumph.
In addition to their popularity the concept of index funds has been endorsed by many leading experts on investing including Warren Buffet, Charles Schwab, and Peter Lynch. Perhaps the highest praise was given by Paul Samuelson, the first American to win the Noble Prize in Economics. Samuelson said, “I rank Bogle’s invention [index funds] along with the invention of the wheel, alphabet, Gutenberg printing, and wine and cheese…” High praise indeed.
So whether you are a Deadhead, Cheesehead, Parrothead, some other kind of head, or none of the above, when it comes to investing you should seriously consider becoming a Boglehead. It will allow you to achieve superior investment results without taking a lot of time and effort to do so. For almost everyone it is clearly the best way to go.