How Index Funds Went From Being Mocked to Feared in 50 Years

The reversal in yields engineered by Treasury Secretary Scott Bessent’s buyback plan lasted just a day after federal borrowing crossed $40 trillion. Thursday’s stock swoon wasn’t helped by more signs of an ailing American consumer, courtesy of Walmart. Futures point to a rebound that should recoup some of those losses with more retailers set to report quarterly numbers. I’ll be off for a couple of weeks, but my Wall Street Journal colleagues will keep Markets A.M. coming in my absence.

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Index funds went from a punchline to the investing world’s 800-pound gorilla. They’ve been misunderstood at both extremes.

This month marks the 50th anniversary of the Vanguard First Index Investment Trust, now Vanguard 500, the original way for individuals to passively own the S&P 500 index.

The fund had an inauspicious start. Founder Jack Bogle raised just $11 million, about a 10th what he had hoped, and it was dubbed “Bogle’s Folly.” Telling people they could be average turned out to be a tough sell, even though expenses were much higher for actively managed funds.

“It took a very long time to recognize that cost mattered,” says Rodney Comegys, Vanguard Capital Management’s chief investment officer.

But Bogle had reason to be confident the product would catch on eventually. Academics had shown that it was hard to beat the market.

And by the early 1970s the idea was working its way into the mainstream. In his bestselling “A Random Walk Down Wall Street,” Burton Malkiel quipped that “a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.”

It’s remarkable, though, how passive investing’s edge has persisted now that it controls more than half of U.S. fund assets. Many had speculated that active managers would close the gap as they pored over a shrinking slice of the market.

But in the past 15 years only 10% of U.S. mutual-fund managers tracking the S&P 500 have beaten the index, according to S&P Global.

That has given rise to accusations that index funds are so big they can’t help but win. As 401(k) contributions flow into target-date funds on autopilot, they buy stocks without regard to price—only their index weight. Active managers have the option of just mirroring the index and making themselves irrelevant or picking stocks with smaller index weights not lifted as much by the gusher of savings.

Nonsense, says Comegys. If there’s a market distortion then there’s still plenty of opportunity to take advantage. Moreover, there are now more indexes than stocks in the world. You lose efficiency, though.

“You can slice that bologna a little too thin,” says Comegys. “Scale does matter.”

Scale gives a massive edge to one-time upstarts like Vanguard. It would be foolish to start a new, even cheaper S&P 500 index fund today to steal market share.

But maybe the surprise of the next half-century will be that there’s more meat there for the investing public. Expenses are approaching zero thanks to the Bogle revolution, and ETFs are hyper-efficient. His insight was the passive advantage, not something magical about one particular index.

A 10th of a percentage point in additional expense matters much less if benchmarks like the S&P 500 are a little too popular for their own good.

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🔎 BJ’s Wholesale Club: The membership warehouse club chain is set to report its earnings ahead of the opening bell.

The old advice to Americans was to vacation in Europe but never invest there. That’s looking outdated.

📰 On this day in 1999, a record price of $2.65 million was paid for a membership seat on the New York Stock Exchange. It was quite a rise from the record low price for a seat, set in 1942, of $17,000. Five years later, seats only would fetch around $1 million.

WSJ | Buy Side: Flat-fee financial advisers charge a fixed dollar amount for their services, regardless of clients’ portfolio sizes.

Business and finance have fascinated me for a long time. Before writing this newsletter, I edited The Wall Street Journal’s Heard on the Street team for a decade, wrote two investment books and managed a team of stock analysts at a global investment bank.