Professor Burton Malkiel discusses the evolution of indexing.


Scott Puritz: Well, that’s a great, great story. What was your involvement with the Vanguard in the creation of the index funds?

Burt Malkiel: Well, I was actually in Washington on the President’s Council of Economic Advisors when Jack started the first index fund. The moment I left Washington though, I joined the Vanguard board and was, as you could imagine, an enormous supporter of indexing. But it wasn’t popular at the beginning, in fact, it wasn’t popular for years. I used to joke with Jack Bogle that at the beginning I thought he and I were the only ones who owned the first index fund. So, it took some time to catch on but eventually it did catch on and now more than half of the fund money in mutual funds and exchange traded funds is in fact in low-cost index funds. And when I say low cost, now the cost has essentially been competed down to essentially zero.

Mitch Tuchman: Just on that Burt, so here you guys are 50 years ago and you’re the only people advocating for an index fund and you said it took many, many years. How many years before you guys said to yourselves, “We’ve started to hit a tipping point, something’s actually beginning to catch on.” How long did you have to just slug it out with no other, no one else admiring your ideas except the two of you or a group of you?

Burt Malkiel: I would say the first decade was almost a lost decade for the idea. The second decade there was at least a little investing but it was really till 20, 30 years later that the idea came across as being good. It was helped in part by the Standard & Poor’s Corporation that does each year a so-called SPIVA study. SPIVA stands for Standard & Poor’s Indexes Versus Active management. And each year they look at active managers and ask if they have outperformed. What’s really interesting and we’re talking now in early January, every January when I listen to CNBC, I get professional investors who are saying, “Well, the index worked okay last year but this is a stock pickers market.”

And each year when Standard & Poor’s does its report, we get the same, same results. Namely, that each year a third of the active managers are beaten by the index and the one third that win in the one year aren’t the same ones that win in the next year. So, that when you compound the returns over 10 and 20 years, Standard & Poor’s consistently shows that 90% of professional managers are outperformed by the index. Now, I’m not saying that it’s impossible to outperform but when you try to do that, you are far more likely to be in the 90% of the distribution than that top 10%. It’s virtually impossible in advance to know who those 10% of the managers are going to be. You can’t do it by who did it in the last decade.

I know a couple of years ago, I remember I was giving a talk and someone said, “You’re crazy.” Cathie Wood and her Ark Innovation Fund just went up 150% and the Standard & Poor’s was just over 10%, of course, you can do better. Well, that fund which was selling at $150 a share then went down into the $30 range, which is where it’s selling now. So, look, the evidence just piled up and eventually people caught on and indexing particularly in the last decade became increasingly popular and increasingly popular because we know it’s not a mediocre strategy. It’s not who wants to be average, it’s not average, it’s above average and in fact, just one more statistic from Standard & Poor’s, the average actively managed fund underperforms a low-cost index fund by about 1% a year.

And so, people finally, it may take a while, but they catch on and indexing has proved itself not to be a mediocre strategy but to be an above average and very sensible strategy for the individual investor.

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