SPEAKER_00: Amazing, fascinating stories of inventions, ideas and innovations. Yes, this is the podcast about the things that have helped to shape our lives. Podcasts from the BBC World Service are supported by advertising.
SPEAKER_03: Well, well, well, shopping for a car? Yep. Carvana made financing a car as smooth as can be.
SPEAKER_02: Oh, yeah? I got pre-qualified instantly and had real terms personalised just for me. Doesn't get much smoother than that.
SPEAKER_02: Well, I got to browse thousands of car options on Carvana, all within my budget. Doesn't get much smoother than that.
SPEAKER_03: It does. I actually wanted a car that seemed out of my range, but I was able to add a co-signer
SPEAKER_02: and found my dream car. It doesn't get much... Oh, it gets smoother. It's getting delivered tomorrow. Visit Carvana.com or download the app to get pre-qualified today.
SPEAKER_01: Hello, Tim Harford here. Jack Bogle, the creator of the world's first index mutual fund, has died at the age of 89. $10trillion are now invested in funds like the one he pioneered. Loyal listeners to 50 Things that made the modern economy may recall that we devoted an episode to Jack Bogle and his invention, and this seemed like the right moment to repeat that episode. One more thing. Season two of 50 Things is in production. From the beehive to the brick to the blockchain, we'll have more stories of often underrated inventions and their unexpected consequences coming to the World Service and to this podcast feed at the end of March.
SPEAKER_03: Here's a question. What's the best financial investment in the world? If anyone knows the
SPEAKER_01: answer, it's Warren Buffett. Buffett is the world's richest investor and one of the world's richest people, full stop. He's worth tens of billions of dollars accumulated over decades of savvy investments. And Warren Buffett's advice? It's in a letter he wrote to his wife advising her how to invest after he dies. And it's been published online for anyone to read. Those instructions, pick the most mediocre investment you can imagine. Put almost everything into a very low-cost S&P 500 index fund. Yes, an index fund. The idea of an index fund is to be mediocre by definition, to passively track the market as a whole by buying a little of everything rather than trying to beat the market with clever stock picks. The kind of clever stock picks that Warren Buffett himself has been making for more than half a century. Index funds now seem completely natural, part of the very language of investing. But as recently as 1976, they didn't exist. Before you can have an index fund, you need an index. In 1884, a financial journalist called Charles Dow had the bright idea that he could take the price of some famous company stocks and average them, then publish the average going up and down. He ended up founding not only the Dow Jones company, but also the Wall Street Journal. The Dow Jones Industrial Average didn't pretend to do anything much except track how shares were doing as a whole. But thanks to Charles Dow, pundits could now talk about the stock market rising by 2.3% or falling by 114 points. More sophisticated indices followed – the Nikkei, the Hang Seng, the Nasdaq, the FTSE and most famously the S&P 500. They quickly became the meat and drink of business reporting all around the world. Then in the autumn of 1974, the world's most famous economist took an interest. The economist's name was Paul Samuelson. He had revolutionised the way economics was practised and taught, making it more mathematical, more like engineering and less like a debating club. His book, Economics, was America's best-selling textbook in any subject for almost 30 years. He advised President Kennedy. He won one of the first Nobel Memorial prizes in economics. Samuelson had already proved the most important idea in financial economics – that if investors were thinking rationally about the future, the price of assets like shares and bonds should fluctuate randomly. That seems paradoxical, but the intuition is that all the predictable movements have already happened. Lots of people will buy a share that's obviously a bargain and then the price will rise and it won't be an obvious bargain any more. That idea has become known as the efficient markets hypothesis. It's probably not quite true. But the efficient markets hypothesis is true-ish, and the truer it is, the harder it's going to be for anyone to beat the stock market. Samuelson looked at the data and found, embarrassingly for the investment industry, that indeed in the long run most professional investors didn't beat the market. And while some did, good performance often didn't last. Samuelson laid out his thinking in an article called Challenge to Judgement, which said that most professional investors should quit and do something useful instead, like plumbing. And Samuelson went further. He said that since professional investors didn't seem to be able to beat the market, somebody should set up an index fund – a way for ordinary people to invest in the performance of the stock market as a whole without paying a fortune in fees for fancy professional fund managers to try and fail to be clever. At this point something interesting happened. A practical businessman actually paid attention to what an academic economist had written. John Bogle had just founded a company called Vanguard, whose mission was to provide simple mutual funds for ordinary investors. No fuss, no fancy stuff, low fees. And what could be simpler and cheaper than an index fund, as recommended by the world's most respected economist? And so Bogle decided he was going to make Paul Samuelson's wish come true. He set up the world's first index fund and waited for investors to rush in. They didn't. When Bogle launched the first index investment trust in August 1976, it flopped. Investors weren't interested in a fund that was guaranteed to be mediocre. Financial professionals hated the idea. Some even said it was un-American. It was certainly a slap in their faces. Bogle was effectively saying, don't pay these guys to pick stocks because they can't do better than random chance. Neither can I, but at least I charge less. People called Vanguard's index fund Bogle's Folly. But Bogle kept the faith. And slowly, people started to catch on. Active funds are expensive after all. They often trade a lot, buying and selling stocks in search of bargains. They pay analysts handsomely to fly around meeting company directors. The annual fees might sound modest, just a percent or two, but they soon mount up. Eventually, these can eat away a quarter or more of a typical fund. Now, if the analysts consistently outperform the market, that's money well spent. But Samuelson showed that in the long run, most don't. The super cheap index funds looked over time to be a perfectly credible alternative to active funds without all the costs. So slowly and surely, Bogle's funds grew and spawned more and more imitators, each one passively tracking some broad financial benchmark or other, each one tapping into Paul Samuelson's basic insight that if the market's working well, you might as well sit back and go with the flow. Index investing is a symbol of the power of economists to change the world that they study. When Paul Samuelson and his successors developed the idea of the efficient markets hypothesis, they changed the way that markets themselves worked, for better or worse. It wasn't just the index fund. Other financial products, such as derivatives, really took off after economists figured out how to value them. Some scholars think the efficient markets hypothesis itself played a part in the financial crisis by encouraging something called mark-to-market accounting, where a bank's accountants would figure out what its assets were worth by looking at their value on financial markets. There's a risk that such accounting leads to self-reinforcing booms and busts as everyone's books suddenly and simultaneously look brilliant or terrible because financial markets have moved. Samuelson himself, understandably, thought that the index fund had changed the world for the better. It's already saved ordinary investors literally hundreds of billions of dollars. That's a big deal. For many, it will be the difference between scrimping and saving or relative comfort in old age. In a speech in 2005, when Samuelson himself was 90 years old, he gave Bogle the credit. He said, I rank this Bogle invention along with the invention of the wheel, the alphabet, Gutenberg printing, and wine and cheese. A mutual fund that never made Bogle rich, but elevated the long-term returns of the mutual fund owners. Something new under the sun.
SPEAKER_03: John C. Bogle told his story in the Wall Street Journal article, How the Index Fund Was Born, on September 3, 2011.
