This article first appeared on Forbes.com.
Modern Portfolio Theory, the work of Markowitz, and Sharpe, and many, many others, is the foundation of how we think about finance and financial markets. Both Markowitz and Sharpe won the Nobel prize in Economics, and many of their intellectual descendants have done so as well. One of the primary implications of the theory is the economic benefit of diversification – a sort of investing free lunch. The well-diversified investor enjoys the same expected return as her less diversified brother, but she is taking less risk.
John Bogle arguably did as much or more for investors than any Nobel prizewinner, although he never won one. His great contribution was practical, not theoretical: he enabled every investor to reap diversification’s benefits at a much lower price than anyone dreamed possible.
Institutional investors (endowments and pension funds) and rich people are usually the first to have access to new investing ideas. Bogle and his new company, Vanguard, introduced the S&P 500 index fund to individual investors in 1976, about the same time the first index strategies for institutional investors appeared.
Vanguard’s first index fund profoundly democratized investing. It was available directly – investors didn’t need a broker to buy it. There was therefore no sales load, no commission to be paid to any salesperson. And it was cheap, with fund expenses a fraction of those charged by other stock mutual funds. It was a revolution.
Indexing is conventional wisdom now, but it was a crazy idea in 1976. Investing professionals and competing investment management firms had two fundamental objections:
- No investor in their right mind would want average returns (from buying every stock) when active managers (the entire investment industry at the time) delivered excellent returns (by picking stocks that would perform well).
- No business charging so little could possibly be viable.
Vanguard’s forty-plus years of growth and current powerful industry position show how wrong they were, and how right Bogle was.
Bogle’s life work was perfectly timed from another perspective. The transition of US retirement funding from pensions to defined contribution retirement plans such as 401(k)s and 403(b)s turned millions of Americans into investors. The availability, and now near-ubiquity, of stock and bond index mutual funds have offered these plan participants, who often know little about securities and don’t care to know more, a safer and much more efficient way to invest their nest eggs.
Just as Milton Friedman said “we are all Keynesians now,” when it comes to investing, we are all Bogleians. Any credible investing discussion begins with indexing, and any departure from it requires extensive analysis, argument, and explanation. Any credible investing discussion must address investment costs, and higher costs likewise require extensive support if they are accepted at all.
John Bogle’s innovations allow any investor to build an extremely diversified portfolio, easily and at very low cost. He made investing less expensive and safer. Along with Edison and Ford, Gates and Jobs, he belongs to the pantheon of American innovation.
