The ultimate buy-and-hold

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John Bogle gave birth to the retail index fund industry by creating the Vanguard 500 Index Fund in 1975. Now he thinks he has a better baby. The old one is too active in its trading, he says; it runs up too much overhead, and it imposes too much in tax costs on its investors.

All this will come as a surprise to the customers of this immensely successful $88 billion fund. The fund’s turnover is a minuscule 6%. Its expense ratio is a rock-bottom 0.2% of assets annually. And it pays out negligible taxable capital gains.

Is this bad? Well, yes, at least compared with a platonic ideal of fund investing that Bogle carries around in his head. His proposed ultra-passive, ultra-low-cost fund will probably not be implemented by Vanguard or any other vendor. But you can create a very good imitation on your own.

Bogle recommends the ultimate in buy-and-hold investing: a completely static portfolio. He would buy the 50 largest companies in the S&P 500 and then never buy another. The portfolio would ignore the constant small adjustments that Standard & Poor’s makes in the index. If a stock were lost in a merger, Bogle would not replace it.

The Vanguard 500 Index incurs (small) transactional costs when people buy new shares or cash out. Bogle would avoid these costs by opening the doors only once-in the manner of a unit trust-and requiring people to take redemptions in kind. In lieu of cash, a departing customer would have to accept so many shares of GE, so many of Wal-Mart, etc.

Do you miss much performance by mechanically buying only large companies? Quite the opposite. At our request, Professor Jeremy Siegel of the Wharton School calculated a hypothetical return (before transaction costs) if someone bought the 50 largest S&P 500 stocks on Dec. 31, 1950 and held on. Average annual return: 12.6%, a fraction of a point better than the market (which Siegel defines as all listed stocks). He then created separate buy and hold portfolios for every year since until 1996. Result: the buy-and-hold approach beat the market three-quarters of the time and it never underperformed by more than 0.6% a year.

Bogle says even the worst case scenario of losing a fraction of a point of return is worth it in order to get a totally static portfolio. He estimates that taxes and transaction costs (not just commissions, but bid-ask spreads) skim 4.5% annually out of returns for most investors in actively managed funds, and 1.5% even for investors in an index fund.

Bogle figures his static-50 fund would cost 0.15% of assets to run. Alas, his successor as chief executive of the nonprofit Vanguard Group, John Brennan, doesn’t plan to offer the product. Creating new portfolios annually (because newcomers would not be allowed into an existing portfolio) would be an administrative headache with each distinct one lacking sufficient economies of scale, Vanguard believes.

So do it yourself. Get a copy of the 500 Index prospectus and buy the 50 largest stocks. Hold forever, except maybe to take an occasional $3,000 tax loss that you can write off against your salary. (Buy the stock back after 31 days.)

One big caution, with which Bogle agrees: All 50 stocks may currently be overpriced (read the story on page 294). But if you are planning to hold for 50 years, this might be a good idea.

Artigo publicado originalmente no site da Forbes, em junho de 1999.

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