An Unlikely Effect of Jack Bogle’s Creation: Helping to Keep Inflation Low
By Jeff Sommer Feb. 22, 2019
A month after Jack Bogle’s death, evidence of the good things he wrought continues to arrive, sometimes from unexpected places.
Jack created Vanguard as a penny-pinching institution owned by its funds’ shareholders. He popularized low-cost index funds and, in the process, radically reduced the expenses incurred by millions of rank-and-file investors.
Now, it turns out, cost savings from various types of index funds, run by Vanguard, BlackRock, Fidelity, Schwab, State Street and others, are having a measurable impact on inflation much as prices for groceries and gasoline do.
In January alone, the Bureau of Labor Statistics found, overall portfolio management costs in the United States “plunged 5.2 percent,” Michael Feroli, the chief United States economist at J. P. Morgan, said in a note on Feb. 14.
Until then, I hadn’t realized that the government tracked management expenses paid by investors. But Mr. Feroli set me straight. He said the effect of falling fees was great enough to make a difference in inflation numbers broadly.
In an email, he said most of the decline in portfolio costs, which the Bureau of Labor Statistics incorporates in the Producer Price Index, could be attributed to cuts in fund fees. That includes traditional mutual funds and exchange-traded funds, a type of index fund.
Index funds generally take a humble approach, mirroring the performance of the markets and not trying to beat them, as actively managed funds do. The simplicity of index funds typically leads to cost savings, which have helped to make them popular.
The decline in fund costs in January, Mr. Feroli said, will probably subtract “several basis points” — a basis point is 0.01 percent — from inflation, as measured by the core Personal Consumption Expenditures index. That is the Federal Reserve’s preferred metric for setting interest rates.
That may not seem like much of a drop. But for core inflation, which affects just about everyone, it is. “Every basis point matters,” Mr. Feroli said.
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The plunge in investing costs continues a long-running trend that Jack Bogle helped to put in motion. From the beginning, Vanguard took pride in its rock-bottom fees the way other companies bragged about their handsome profits.
By now, so many investors have flocked to Vanguard’s low-cost funds that many other companies offer them as well. A virtuous cycle has taken hold, much as Jack hoped.
The average fee paid by stock index fund investors plummeted nearly 40 percent in the decade that ran through December, Morningstar data shows. Fees for actively managed stock funds dropped about half that amount, and in December, they were still more than five times as high as those associated with index funds.
The shift to index funds has translated into big savings for individual investors. Imagine, for a moment, that you had $100,000 to invest in a retirement account. If you held the money in an actively managed stock fund that charged the average fee for 2008, you would have paid $927.06 a year in fees. At the average fee for an index funds in December 2018, on the other hand, your annual fee would have been only $141.83 a year, a savings of $785.23.
Over the course of a decade, a huge number of people took advantage of those savings by moving from actively managed to index funds.
In December 2008, new Morningstar data shows, only 19.8 percent of mutual fund assets in the United States were in index funds. Ten years later, the proportion had almost doubled, to 38.7 percent. And two companies that emphasize index funds — Vanguard and BlackRock (including its iShares E.T.F.s, which BlackRock acquired in 2009) — grew to dominate the industry.
By December 2018, Vanguard accounted for 24.8 percent of all stock and bond mutual fund assets in the United States, according to Morningstar. And Vanguard and BlackRock together controlled more than 34 percent of those assets. The two companies continue to attract enormous sums of money around the world: $176 billion flowed into Vanguard last year; $167 billion went to BlackRock. Fidelity was a “distant third’ with $24 billion, Morningstar said.
“In effect, we are living in a Vanguard-BlackRock duopoly,” said Kevin McDevitt, a senior analyst with Morningstar. The two are so big that everyone else must respond to them, he said, often by slashing costs.
Last summer, Fidelity announced that it was cutting fees to zero for some of its mutual funds. Charles Schwab quickly followed suit. Now, Fidelity and Schwab are offering broad arrays of exchange-traded funds that may be bought and sold without commissions, competing with Vanguard, which already does so.
That’s why the index fund revolution hasn’t been a blessing for all profit-making asset management companies. Revenue that would have swelled corporate coffers has instead remained in the pockets of people who shifted their savings into low-cost funds.
Companies that focus on actively managed funds with higher fees have had a hard time over the same period. For example, investors pulled $44 billion out of Franklin Templeton in 2018, Morningstar estimated. Partly because of that, the company’s parent, Franklin Resources, reported a sharp decline in earnings per share, to $1.39 in 2018 from $3.01 in 2017, according to public filings.
From other perspectives, the effects of low-cost index funds may not turn out to be entirely positive. The implications of concentrating market power in the hands of a few giant investment companies have yet to be fully understood.
But the benefits are clear. For consumers, paying less for a bag of apples or a gallon of gas is a good thing. So is paying less for the privilege of owning a piece of the stock or bond market. As costs drop, Jack Bogle’s legacy lives on.
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