Once-derided fund turns 30



If only every "worst idea" were so successful.

The Vanguard 500 index fund turns 30 at the end of this month. Once snubbed by Wall Street, it is now the nation's second largest mutual fund, with $107.6 billion in assets. It has had an impact even on investors who never put a dime in it.

The 500 fund was the first index mutual fund ever offered to small investors. Its low fees have pressured other funds to keep costs down, too, experts say. And it spawned hundreds of imitators that track every imaginable benchmark.

"Maybe the greatest measure of the fund's success is how many imitators it has," says Sonya Morris, an analyst with Morningstar Inc.

As of a few weeks ago, more than $1 trillion was invested in index funds, according to fund tracker Lipper Inc. That's about one out of every $9 dollars invested in U.S. mutual funds. (Full disclosure: I own shares of Vanguard 500.)

The idea behind the Vanguard 500 is simple. The fund mimics the Standard & Poor's 500 index by buying the same stocks in similar proportions. Up until the Vanguard 500, the only funds available to small investors were actively managed funds where professionals pick securities to try to beat - not meet - an index.

Vanguard Group founder John Bogle says the fund at the outset was derided as "Bogle's folly" and "the worst idea in history." About $11.5 million dribbled into the fund when it opened, far short of the $150 million that had been anticipated, Bogle says. Underwriters even suggested returning the money to investors.

The fund was ignored for years, Bogle says. "It was so under the radar."

Investors started taking notice in the mid-1980s, when as many as 90 percent of actively managed funds failed to outshine their benchmarks, Bogle says. (For the first half of this year, only about 40 percent of large-cap and mid-cap actively managed funds beat their benchmarks, according to Standard & Poor's.)

The big advantage of index funds are low fees because they do little trading and don't need to pay for research.

Still, even after 30 years, the debate rages on whether an index or actively managed funds are better. And it's not likely to be resolved soon.

"As long as you have any active manager outperforming an index, they can make the case they can provide superior returns," says Jeff Tjornehoj, a Lipper senior research analyst.

However, many academics and financial planners recommend index funds for small investors who don't have the time or knowhow to research funds.

Conrad Ciccotello, director of graduate personal finance planning programs at Georgia State University, says investors can keep things simple by dividing money between a bond index fund and a total stock market index fund made up of all stocks. The younger the investor, the more money in the stock fund, he says.

That advice may come in handy now that the new pension law requires workers to take even greater responsibility for their retirement.

Next month, Bogle will celebrate the Vanguard 500's birthday at New York's 21 Club with others involved in its launch. He feels vindicated, noting that 40 percent of the 364 stock funds in existence in 1976 are now defunct.

Questions? Comments? Write personal.finance@baltsun.com.

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