Vanguard CEO Discusses Poor Performance of Index Funds During Last Decade

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Vanguard’s CEO, Bill McNabb, gave a CNBC interview yesterday discussing the poor performance of his Vanguard index funds during the last decade after the recent stock market crash.

If you have been reading this blog for a while, you would know I’ve been rather outspoken on index funds calling them bad investments.

Primarily because they are so susceptible to sell offs in the broad market, and are essentially held hostage to one major factor – the outlook of the U.S. economy.

Unless you’ve been living under a rock, you’ve probably heard the U.S. economy has been looking rather peaked lately considering the fallout from the financial crisis is only now becoming visible, and the subsequent trickle down effects from Wall Street to Main Street are being felt.

The recent crash has really shown the Achilles’ heal of the index fund industry with their inability to actively buy and sell stocks. In an actively managed mutual fund, the manager has the ability to sell stocks prior to a sell off like we witnessed to what will likely be known as the “Stock Market Crash of October 2008“. Of course, the skill of the manager is the key factor and each individual investor is responsible for finding those mutual fund managers that have the ability to outperform the S&P 500.

For the record, I own several Vanguard index funds for my retirement accounts, but as Erin Burnett echoed her (and my) feelings during the interview, we’ve seen returns that are “pretty disturbing”.

Here are the shortened, paraphrased answers to the questions posed to Vanguard’s CEO during the interview:

Are everyday investors withdrawing money from your Vanguard index funds or putting more money into their accounts? In general, we think investors are holding in there. We saw an uptick in call volumes and website traffic, but we think the majority of people were buying while the bad news was as it’s highest.
How do you respond to questions of index funds being bad investments over the last ten years? Bad luck perhaps? We’ve seen a return of 0.5% for each year invested after calculating for paid dividends in our index funds, but it’s certainly one of the worst time periods we’ve seen for the broad index. We think broad diversification is the way to proceed for the future. Note: I really wasn’t satisfied with this answer.
What mistakes do you see 401k and/or IRA customers making in their Vanguard retirement accounts? The mistakes we see are the investors operating on the extreme margins. By this, I mean people who invest solely in money market funds which can’t get the larger returns on their money they need over time. Alternatively, you have investors who were seduced by extravagant gains in high risk sectors, like emerging markets, and are now paying the price.

Perhaps I’m somewhat jaded by the poor performance of my own investments, but I personally didn’t find much comfort in the interview. Of course, I can’t imagine that anyone would be happy to find out that after 10 years of diligent investing that their investments only had a 0.5% annualized rate of return. Especially, since I’m paying a small management fee to use their services, and I could have found a savings account with a higher interest rate for my money.

However, the bigger picture is that I’m still accumulating equities and I have 30 plus years until I retire. As the tone of the interview suggested, the feeling is that many index fund investors were (in my opinion) lured by the mantra of low cost investing only to be disappointed in the end.

Let’s just hope the next decade shows some improvement!

The full interview can be viewed here at this CNBC video link.

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