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stock indices

The Birth of Index Funds

Most are familiar with the idea that a trader buys into a company to seek profits. There is a way to take this a step further and buy many companies at the same time. We are talking about Index Funds. Let’s take a closer look.

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The first ever index fund was introduced by Wellington Management Company, under a new division known as Vanguard. This fund was created by John C. Bogle, who was CEO of the company just prior. He made mistakes with a merger and instead moved inside the company to manage this new fund.

This was a chance for Bogle to try something new, and he had inspiration to help him do so. Bogle had become familiar with the writings of Nobel-winning economist Paul Samuelson. Samuelson had an article in Newsweek in 1976 that was espousing the need for funds that followed indices such as the S&P 500.

Bogle took this idea and ran with it. It was not entirely revolutionary to offer mutual funds based on stock indices. American National Bank and Wells Fargo had begun offering this a few years prior to institutions. Vanguard was the first to offer it publicly, to individual investors. They called it the First Index Investment Trust. Its IPO only gathered $11 million, when the target was $150 million.

The big problem it faced is rather ironic: it didn’t give a commission to the brokers who sold it. This is clearly good for investors, yet it made the fund largely ignored at first. Brokers would have been the mechanism for growth of this fund, but no commissions meant they had no interest in promoting it. People in the trading world would sometimes call the fund “Bogle’s Folly”, due to its bad start and a distaste for that the model of passive management and no commission. It was sometimes even called “un-American”.

Indexed funds grew despite this rocky start. From 1976 into the 1980s, growth was slow. In 1985 there was about a half billion USD in indexed funds. By 1993 this had ballooned to tens of billions, or about 3% of the market share.

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