The idea of an index fund seemed a bit of a joke at first. Indiscriminately buying hundreds of stocks, then accepting whatever return the market provided?
Aside from being impractical to build in the infancy of computers, an index fund was an insult to investors who prided themselves on picking the best stocks out of thousands. It sounded pretty cool to economics professors and a few of their financial geek students. Almost everyone else “thought we were crazy,” Oldrich Vasicek, a mathematician who worked on one of the first index products, once recalled in an interview .
“They said, ‘You want to buy all the dogs. … You just want to buy whatever garbage happens to be traded?’”
In 1960, two University of Chicago graduate students published an article in Financial Analysts Journal calling for an “unmanaged investment company.” “Investment companies as a whole have not outperformed representative stock averages,” Edward Renshaw and Paul Feldstein wrote, so why not offer a portfolio that automatically buys every stock in the Dow Jones Industrial Average or some other index?
Easier said than done. It wasn’t until the early 1970s that Vasicek and others at Wells Fargo tried using computers to build index portfolios for pensions. And it wasn’t until Aug. 31, 1976—40 years ago today—that a new firm started offering an index mutual fund, one that anyone could invest in.
Today, that firm, Vanguard Group, is the largest fund company in the world, with $3.6 trillion in assets. Buying an index fund is now the conventional wisdom, even if it means giving up your hopes of outperforming the market with a smart manager. In the 12 months that ended in June, Morningstar estimates, investors pulled $317 billion from actively managed funds while putting $373 billion into passive index funds.
But back in 1976, an investment firm executive wrote that all but “a very small minority” believe “index funds are a ‘cop-out’ and a fad that will soon disappear.” Indexing’s biggest fans in the 1970s were mostly on campus.
Nobel Prize-winning economist Paul Samuelson touted indexing in his column in Newsweek, attacking investors’ “Napoleonic delusions of being able to pick winners that will quadruple their money.” Princeton economist Burton Malkiel’s 1973 book, A Random Walk Down Wall Street, spread the idea that it was almost impossible for an active mutual fund manager to beat the market in the long term.
The problem was that no mutual fund existed that offered the general public that “random walk.” And Wall Street firms had no incentive to create a product that would bleed away their profits.