The Age of Mutual Funds

The concept of a stock is not a new one. Nearly four hundred years ago, shares were issued by the East India Company to help pay for its voyages and colonial conquests in Asia. In America, the New York Stock Exchange (NYSE) was formed in 1792 when a group of brokers signed the Buttonwood agreement – named after a large Buttonwood tree which existed on Wall St at that time. In those innocent times brokers conducted trading under that shady tree, scampering to the nearby Tontine coffee house during inclement weather. But before we get too misty-eyed it is worth noting that the Tontine coffee house was also a hub of many other forms of trading, including African slaves who were registered there before being sent off to the cotton plantations.

The NYSE has certainly experienced remarkable growth but the idea of paying someone else to pick a portfolio of stocks did not come into its own until the 1920s, when the first mutual funds were launched. An interesting bit of history here is the Wellington Fund, launched during that time which still exists today (ticker: VWELX). It was managed for a while by John Bogle who is the founder of Vanguard investment company, prolific author, and one of the few true pioneers of the investment industry. By a quirk of fate, both Mr. Bogle and the Wellington Fund are approximately equally old, about 86 years.

The mutual fund industry attracted a lot of Federal attention, culminating in the 1940 Investment Company Act which regulates most aspects of these funds. Even today, mutual funds are referred to as “40 Acts” in the financial world. However, stocks continued to be thought of as highly risky assets – not something meant for the common man or woman. In the early 1980s more than 80% of American households did not hold any stocks whatsoever. And barely 1 in 20 families were invested in a mutual fund. They were things that rich people bought, much like hedge funds are today.


But unknown to all, President Jimmy Carter had already delivered a completely un-intended favor to the mutual fund industry. Back in 1978, he had signed the Revenue Act which happened to have a provision for tax-protected savings accounts – a small thing called “section 401(k)”. The provision was so obscure that it’s significance was not recognized for several years. But once it was, mutual funds expanded like wildfire and by 1999 the industry had grown by ten-fold with about 1 in 2 American households owning stocks and mutual funds.

The 401(k) provision literally rained money on fund managers, and also contributed to a magnificent stock market rally : the S&P 500 rose at the rate of 15% per year between 1985-95!

What about the rest of the world? Most Americans would be surprised to know that stock ownership in other countries remains low, even in Europe and Japan. This is because retirement is typically state-sponsored outside the US and the need for accounts of the 401(k) type has not been felt until quite recently. Even today, only 10% of Germans and 20% of the British are invested in any stocks whatsoever. The Japanese are even further behind.

That could change in the future because both the European and Japanese systems are literally groaning under state debt. Their shrinking working-age populations will not be able to support the ever increasing proportion of long-lived seniors much longer.

The aging problem is not unique to Europe and Japan, it is just as surely creeping upon the United States. In 1970 there were 4 workers to every retiree and today there are less than 3. This is projected to go down to a mere 2 workers per retiree over the next few decades. To my mind, the next big wave of stock investing in the US will likely happen when Congress finally starts moving Social Security towards private accounts.

As you may be aware, this is a bit of a political hand grenade in today’s climate given the suspicion of anything related to Wall Street. The hapless George Bush tried to introduce private accounts in 2005, but like a lot of his initiatives this too was doomed to fail.

Leaving aside the politics, the truth is that investments in stocks and bonds are hardly a give-away to Wall Street at this point. Back in the 1980s and 90s, fund managers could easily charge 1-2% of assets as fees for their services. But now we have a plethora of ETFs where the fees are abysmally low. For example, Vanguard has an ETF (VOO) which allows you to buy the S&P 500 for a mere 0.05% annual fee. Charles Schwab has come out with something even lower – 0.03% fee for the same exposure (SCHB). Rest assured, nobody is getting rich on those fees.

With that question settled, we shall see in another post that the idea of allowing private accounts makes too much sense to never see the light of day.