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Vanguard steady on course
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December 28, 1998: 10:42 p.m. ET
Index fund beats most money managers, even beats its own index
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NEW YORK (CNNfn) - Jack Brennan, chairman and chief executive officer of Vanguard Group, said Monday investors should pick their mutual funds carefully rather than trying to chase the latest high-flying fund to hit the market.
In an interview Monday on the "Moneyline News Hour with Lou Dobbs" Brennan said investors should also limit the number of funds they hold to a relatively small list of funds.
Here are highlights of that interview, which was conducted by host Jan Hopkins:
JAN HOPKINS, HOST: Vanguard's 500 fund is outpacing the index that it mimics. It's up more than 28 percent for the year, while the S&P 500 is returning 26.4 percent. So this must be a managed fund if you're outperforming the index.
JACK BRENNAN, CHAIRMAN & CEO, VANGUARD GROUP: No, not at all. Not at all. There's a few tricks to add a little bit here and there, but no one should expect us to perform anything but right on the index when we're performing well.
HOPKINS: Now, it's interesting because this year, the index funds have outperformed the managed funds, by and large. Do you expect that kind of performance to continue into the future?
BRENNAN: Well, over the long term, an index fund should outperform a comparable, actively managed fund on average. Because of lower cost and lower turnover, it has a big head start.
You know, it's been an exceptional run for the S&P 500 as a group of stocks. Large and growth has been the place to be. The S&P 500 is dominated by large growth stocks at this stage, so it's been difficult for active managers to catch up on the last several years.
We're on a cyclical roll here, where I think this is the fifth year the S&P will far outperform the average manager. That cycle will turn at some point in time, but if you look in five- and 10-year chunks, you ought to expect to see index funds be far better than average in any category in which they compete.
HOPKINS: Is it a good strategy for investors to pick the best performing stock of the previous year, or rather the best performing fund of the previous year and jump into that fund?
BRENNAN: No, not at all. People ought to pick a fund that meets their need for the long haul, you know? Particularly this time of year, we spend -- we see a lot of speculation on what will fare well next year, what fared well last year. All of that's really irrelevant for our investor who's there for the long haul. They ought to pick a fund that has the risk characteristics they want whether or not it performed well.
If they really want a lot more risk and they want an index fund, they might pick a small cap fund. Or, if they want a broad exposure to the market, they pick a total stock market fund. But looking at last year's performances a very difficult way to make money in the future.
HOPKINS: So, should investors have a lot of funds or just stay in an index fund?
BRENNAN: Well, I think they ought to have a relatively small list of funds. I happened to be working on the phones today talking to somebody, and they had 14 funds in their portfolio, which was less than $100,000, and that to me doesn't make any sense at all. You can create a very effective investment program from just a couple of funds -- key funds in stocks and bonds and a little bit of cash reserves. So, you don't need to be a collector of funds, which is a real risk that people take when they chase last year's best performers. You hear it all the time, and I think fewer is better in the case of investing in funds.
HOPKINS: You were working the phones. What do you learn from investors?
BRENNAN: Well, you learn an awful lot. You learn seasonal things like some misconception that you have to open a Roth IRA by the end of the year. That happened to be a bunch of the calls. You do learn about people's propensity to want to know what performed best in the past and try to buy that, presuming it will repeat itself in the future.
And, frankly, that helps us a lot in our own communication program, as we try to articulate to investors what they should be doing, not, frankly, what they're reading about in today's newspaper based on some very short-term recent event.
HOPKINS: In terms of your investors, did they stick with those index funds when the market was down 20 percent?
BRENNAN: Their performance was remarkable and surprising, frankly, because the last -- you know, that July to the end of August was really a significant test of people's awareness of the risk inherent, particularly in index funds, which are fully invested, and their willingness to ride through a difficult period of time. They've obviously been rewarded very well in the near term since Aug. 31, but we are very impressed by the way people stuck with the program. Those that are regular investors continue to invest and we had positive cash flows every day through that entire period of time.
HOPKINS: You have begun to offer trading online. Is this the future of the industry?
BRENNAN: No, not particularly. It's an accommodation for our clients, you know, and our brokerage services. You have to a mutual fund client to be a brokerage client. We offer it as a way of offering a reduced cost option, a more convenient option for people.
You know, one of the mistakes that a fund company could make would be to try to perpetuate the myth that trading is good and mutual funds are not. If people want to buy and sell stocks, it's one thing. Mutual funds are created and run for the long haul, not to be traded quickly. 
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