'St. Jack' preaches investing in index mutual funds

By John F. Wasik
Bloomberg News Service

CHICAGO — Jack Bogle is the Martin Luther of financial religion.

The 73-year-old former chairman of the Vanguard Group is a bit of a heretic, nailing his low-cost, market-return theses to the door of an industry with 10,000 funds to push on investors. To his followers, known as "Bogleheads," he's simply "St. Jack."

Bogle preaches diversification, low costs and the fact that most stock funds can't beat his simple investment principle: Index mutual funds held over a long period will outperform nearly any single stock or mutual fund.

It's a worthwhile idea to keep in mind in the wake of accounting scandals that have erased the market value of companies such as Enron Corp. and WorldCom Inc. Instead of being exposed to the huge risks of one stock, Bogle says, it's better to bet on the market through an indexed portfolio based on the Wilshire 5000, a representative sample of more than 6,500 stocks on U.S. exchanges.

"If you bet the market is efficient and hold the market portfolio, you'll earn the market's return," Bogle told those of us attending the recent Morningstar Inc. investing conference in Chicago. "If you bet against it and are wrong, the consequences could be painful — not quite like going to hell, but something like that."

I've heard Jack preach for more than 10 years. The sermon's theme hasn't changed once — it just gets better and more focused.

The message is that you can't beat the market by investing in one stock, even if it is your company. And you can't hope to beat the market through most stock mutual funds. After you subtract fund expenses, taxes and managers' bad stock picks, most funds don't come close to beating the market index benchmarks.

One of Bogle's favorite ways of indexing is through the Vanguard Total Stock Market Index fund, which represents the Wilshire 5000 Index.

Even after two years of 10 percent-plus annual losses, and a third in the making, the Total Stock Market fund still beat 76 percent of similar funds over the past five years, Bloomberg data show.

One person who has been converted is Dave Munson, 35, a laid-off telecommunications engineer from Magnolia, Ill., who used to build facilities for WorldCom. He briefly put half his holdings in WorldCom and MCI preferred shares this year, betting on a recovery that never happened.

Munson sold those shares in March and has since diversified into 12 mutual funds, eight individual stocks and 20 percent cash. That helped him dodge a bullet as WorldCom, the second-largest U.S. long-distance provider, lost 98 percent of its value this year and disclosed it had hidden $3.8 billion in expenses.

While Bogle would probably urge Munson to go to all stock- and bond-index funds to reduce costs and improve returns over time, he'd likely approve of the diversification and avoidance of company stock. Some 29 percent of 401(k) participants still have at least 75 percent of their retirement kitties in company stock, according to a Hewitt Associates study, and Bogle considers the practice to be asking for trouble.

Exposure to one stock raises stock-market risk "by as much as two to three times," Bogle has said.

In addition to persuading fund managers to pressure corporations to clean up their accounting and oversight, there are some things Bogle wants individual investors to keep in mind:

• Market returns revert to the mean. That means don't expect double-digit returns in the stock market. Bogle's research shows that average annual stock returns over the past 100 years, when adjusted for inflation, are 6.6 percent. "The most successful investors will respect reversion to the mean," he said.

• In a lower-return environment, costs are critical. An average stock-fund annual expense of 1.57 percent eats up one-sixth of the return of a fund generating 10 percent a year. The same expense ratio devours almost a third of a 5 percent annual return.

Earning the market return is simple. Over time, holding a stock-index fund beats even the largest, actively managed funds.

For example, Bloomberg data shows that the Vanguard 500 Index fund representing the largest U.S. industrial stocks had a 10.4 percent annualized return from the end of 1976 through June, based on month-end calculations. Fidelity Magellan, the largest actively managed stock fund, had a 7.4 percent annualized return in the same period.

"The total market position is the most sensible, tax-efficient, cost-reducing move that doesn't involve any decisions about which fund or manager to choose," Bogle said in his speech.

Faith in diversification will reduce your exposure to the many accounting sins now being confessed by corporate America. If your employer doesn't offer index funds in your retirement plan, start shouting from the pews.