Just when I think there's nothing more to learn from an octogenarian, it's reassuring to be told something I didn't already know. This time, the advice is coming from John Bogle, the founder of the Vanguard Group, as he is interviewed by the editor of the AAII Journal in June.

Among other things, the interview explains why the Wall Street Journal had an article last Monday titled "Hard Time for Stock Pickers."

Index funds, buy the way, are funds that invest in broad cross sections of the stock market with each holding held in proportion to that company's value of outstanding stock relative to the total value of the group as a whole. The oldest is the S&P 500 index of, naturally, the 500 largest companies. The largest index fund is a total stock market fund investing in a representative cross section of the entire market. Index funds do little trading except to maintain correct proportions, and there are essentially no management fees. Some index funds charge as little as one-twentieth of 1 percent per year as an annual expense -- essentially free money management.


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Bogle points out something that had escaped me. He says that while 30 percent of the entire stock market is owned by people who invest directly in index funds, the remaining 70 percent, in the aggregate, are indexing as well, even though this group is actually made up of millions of investors who are trying to beat the indexes. Bogle would argue that the 70 percent is playing a zero-sum game (for every winner, there's a loser). He also says that most investors in this group are held hostage by an investment community that has convinced them that they can beat the averages by paying more than 2 percent per year in management fees and trading costs plus long- and short-term capital gains taxes on successful trades.

As if Bogle's argument wasn't enough, The New York Times on May 31 described research performed by Morningstar, the renowned fund ranking and research service. It measured the correlation between low fees and high performance. While most investors use past performance as their decision-making tool for guessing what might be a winner prospectively, that's like Jay Gatsby peering through the mists at the green light at the end of Daisy's dock -- hoping against all hope. Past performance actually does mean something, and scholars have dubbed the success of past performance as "persistence." Early on, it was called the "hot hands" theory, which more accurately conveys the true nature of the past performance tool to predict future performance. Bottom line: We know who beat the averages in the past, but there is no way to know, prospectively, what fund will be tomorrow's winner.

Comparing apples to apples, Morningstar divided funds into 112 fund types and compared funds only against their competitors of the same fund type. Funds in the cheapest quintile based on fees generally outperformed their peers. The cheapest funds beat more than half of their peers while the most-expensive funds beat only 24 percent.

The Morningstar study essentially confirms what Bogle has been saying since he founded the Vanguard family of funds, and thanks to a heart transplant, he can continue to keep saying it. The Morningstar research team concluded that "low cost is the best single predictor of subsequent performance available. ... It's definitely not past performance."

Index funds are not an invitation to "set it and forget it." Another issue altogether is the question of what mix of index funds to use as part of an asset allocation strategy based on historical risk and reward considerations. Publications such as The Independent Adviser for Vanguard Investors offer good insight into what an index-only fund selection might look like. Meanwhile, it's reassuring to see that octogenarians who resist being put out to pasture can still be offering ideas and stimulating our financial thinking processes.

Contact Steve Butler at 925-956-0505, ext. 228, or subtler@pensiondynamics.com