BOGLE WINS: INDEX FUNDS SHOULD BE THE CORE OF MOST PORTFOLIOS TODAY
By TYLER MATHISEN EXECUTIVE EDITOR

(MONEY Magazine) – For nearly two decades, John Bogle, the tart-tongued chairman of the $155 billion Vanguard Group, has preached the virtues of index funds -- those boring portfolios that aim to match the performance of a market barometer. And for much of that time, millions of fund investors (not to mention dozens of financial journalists including this one) basically ignored him.

Sure, we recognized the intrinsic merits of index funds, such as low annual expenses and, because the funds keep turnover to a minimum, tiny transaction costs. Moreover, because index fund managers convert paper profits into realized gains less frequently than do the skippers of actively managed funds, shareholders pay less tax each year to Uncle Sam. To be sure, those three advantages form a trio as impressive as Domingo, Pavarotti and Carreras.

And yet there was always this nagging conceptual obstacle that kept many investors from embracing the funds that Jack Bogle has pitched so vigorously for Vanguard: When you invest in an index fund, you're settling for average. Or so the thinking goes. For most fund investors, myself included (in fact, I own some actively managed Vanguard funds), the prospect of merely matching the market was simply not good enough.

Well, Jack, we were wrong. Now, just as you prepare at age 66 to step down as Vanguard CEO early next year, we're ready to say it: You win. Settling for average is good enough, at least for a substantial portion of most investors' stock and bond portfolios. In fact, more often than not, aiming for benchmark-matching returns through index funds assures shareholders of a better-than-average chance of outperforming the typical managed stock or bond portfolio. It's the paradox of fund investing today: Gunning for average is your best shot at finishing above average.

Want proof? Then check out the dramatic opening chart that illustrates this month's story by associate editor Walter L. Updegrave, "Why Funds Don't Do Better" (page 58). It shows that in any given year during the past 20 years, as well as over longer periods within that span, your odds of besting the S&P 500-stock index in a diversified equity fund have been depressingly slim. Indeed, only three times in the past dozen years through 1994 have more than 50% of diversified equity funds outpaced the S&P.

"People don't realize how good indexing is," Bogle recently told Updegrave. "Matching the market or almost matching it is not a confession of failure." Far from it, considering that the S&P 500 index topped 83% of all general equity funds over the past decade.

So what gives? Why can't more funds beat the market? And more important, in light of these chilling figures, what should you do now?

The answers to those questions and more are at the heart of this month's 61-page special report on mutual funds. As is our August custom, we provide an exclusive midyear performance update. This year it covers 2,845 stock and bond funds with figures to July 1 -- the largest, timeliest such report in any magazine. But even more than any of our prior midyear mutual fund packages, this one demands your attention. That's because, taken together, Updegrave's trenchant discussion of why funds usually underperform the indexes, plus staff writer Carla Fried's "The New Way to Make More Money in Funds" (page 68) call for nothing less than a complete reorientation of your expectations as a fund investor. What's more, they guide you through a thorough, sophisticated rethinking of how to assemble a winning mutual fund portfolio.

No, we don't think it ought to consist entirely of index funds. As even Bogle admits, some managers have demonstrated an ability to outrun the markets over long periods. "There's no question," he says, "that some people are going to do better." And in foreign markets and selected domestic sectors, such as small-company shares, we believe that certain top stock pickers, whose funds Fried names, can add value.

All in all, though, we've come around to agreeing with the sometimes prickly, always provocative, fund exec known to admirers and detractors alike as Saint Jack: Indexing should form the core of most investors' fund portfolios. So here's to you, Jack. You have a right to call it, as you recently did a Vanguard sales booklet you wrote, "The Triumph of Indexing."

TYLER MATHISEN, EXECUTIVE EDITOR