The Vanguard Group


Letter to the New York Times Sunday Business Editor


By John C. Bogle, Founder and Former Chairman,
The Vanguard Group

July 30, 2000

The following letter to the editor was originally published in The New York Times.

Mr. Jim Schachter
Sunday Business Editor
The New York Times
229 West 43rd Street
New York, NY 10036-3959

Dear Mr. Schachter:

I was most disappointed to read of the premature demise of the contest that The New York Times established in mid-1993, comparing the results of mutual fund portfolios managed by five respected investment advisers with an unmanaged portfolio represented by the Vanguard 500 Index Fund.

Originally specified as a 20-year test of retirement plan investing, the Times reports, without explanation, that after seven years "the exercise concludes after the second quarter of 2000." During that period, the five fund advisers, on average, built the original hypothetical nest egg of $50,000 to a value of $138,500 on June 30, 2000. (The range was $155,000 to $111,800.)

In a curious but pointed omission, nowhere in the Time's story can we find the final value of the unmanaged index fund, the original comparative standard. Yet the whole point of the contest was to see if competent fund advisers could outpace what is essentially the stock market itself. For the record, then, on June 30, 2000, the index fund was valued at $188,750. Not a single adviser portfolio even approached this total accumulation.

Put another way, the advisers earned a seven-year profit for their retirement plan investors of $88,500, compared to a $138,750 profit for the index fund. This $50,000 difference is, simply put, enormous—equal to the entire initial investment. But it understates the reality. For, given the magic of compounding, even if the fund advisers and the index fund were to earn an identical, say, 10% return over the next 13 years (concluding the originally-specified 20-year test), the final value in 2013 would be: Average adviser, $478,000; Index fund, $652,000.

Of course it would take a Herculean leap of faith to forecast that the advisers, having fallen so far behind the Index fund in the past, would start playing, as it were, par golf in the future, particularly when we examine (as the article does not) the reasons the advisers chosen by the Times fell so far short. It comes down largely to a single factor: Cost.

The annual rates of return earned by the fund advisers and the index fund can be calculated from the data in the Times story at 15.7% and 20.9% respectively. Of that 5.2% gap, fully 3.2 percentage points are represented by the estimated costs incurred by the mutual funds selected by the advisers (1.2% expense ratio, 1% portfolio turnover cost, and a 1% opportunity cost from not being fully invested in stocks).

So, what is billed as "a seven-year lesson in the unexpected" proves to be a "seven-year lesson in the expected": Costs are predictable, and they matter; swapping funds doesn't work very well; index funds are hard to beat. Readers are told merely that stocks "are" (I would have said "have been") the best way to meet long term goals; and that "it isn't necessary to get overly complicated" (said by an advisor who has owned several dozen different funds at one time or another in his portfolio).

The Times article also describes an adviser whose "success" (sic) in using an unorthodox approach is "ratified," despite a $38,000 shortfall to the index fund; and another adviser who has learned, he says, "not to make a big bet on a new fund idea." It's unfortunate that this professional had not learned far earlier of that trap for amateurs.

So, the Times study was off to what I considered a predicable beginning. To fail to explore its real lessons is unfortunate; to terminate the competition is tragic. Discontinuing the contest and abandoning the competitive race that has been freely joined by all parties is a real disservice to investors. I urge you to let the race continue. That is the best way to drum home the real message: The challenges and frustrations that even experts face when managing mutual fund portfolios.

What is more, continuing the race will continue to make my Sunday morning trip through your Money and Business section exciting and entertaining!


John C. Bogle

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