Vanguard-vs.-Markman bet shows how tough fund timing can be


The recent resolution of a simple 5-year-old bet shows why fund investors often have such a hard time deciding the "right" thing to do when it comes to choosing funds.

In 1995, Vanguard Group founder Jack Bogle and Bob Markman, head of the Markman MultiFunds, made the classic passive vs. active management wager. They bet $25 that their chosen fund - the Vanguard Index 500 or the Markman Moderate Allocation fund - would come out ahead in five years, winner take all.

Bogle won, but Markman's payoff started a public exchange of letters between the two, and it soon became obvious that even the most simple fund issues are easily blurred. That's why it's hard to pick a fund on which to bet your hard-earned savings.

Here's the skinny on the bet and the spin from both sides.

As of mid-April, when Markman sent Bogle the payoff, the Vanguard Index 500 was up 26.7 percent annualized over the five-year study period, compared with a 20.7 percent annual gain for Markman Moderate, which like all Markman funds invests in other mutual funds instead of stocks.

But Markman noted that he had fallen for a sucker bet because Markman Moderate kept roughly 25 percent of its assets in bonds and cash, while the Index 500 was entirely in stocks.

While acknowledging that his own management errors on the stock side may have contributed to losing the bet, Markman said Moderate's more balanced approach "pretty much doomed me to failure" in a race against a fully invested stock fund.

While it wasn't part of the bet, he took solace in the fact that his fully invested Markman Aggressive Allocation fund topped the index fund with a 27.7 percent annualized gain.

Bogle, however, wasn't offering solace. In his response to Markman, he wrote that the index fund's victory over Markman Moderate "validates the principle that brought me to offer the original bet: The odds in favor of a stock market index fund over any managed fund are powerful, and they get better as the managed fund's expense ratio rises."

What's more, he noted that the Index 500's victory was much greater after taxes were factored in, as nearly 30 percent of Markman's profits would have gone to Uncle Sam, compared with just a fraction of the index fund's gains.

Bogle wasn't buying Markman's pride in beating the moderate fund's true peers, specifically other fund-of-funds, including Vanguard's lower-cost varieties. Wrote the former Vanguard chairman: "Being the best of a breed of losers ... shouldn't entitle you to bragging rights."

The nasty verbal sparring then delved into more arcane subjects. The exchange of letters (you can read it on the funds page at was not the most sportsmanlike show from these spirited, intelligent and likable men.

What's worse is that the bet really didn't settle anything, particularly not what it set out to do, which was show whether active or passive management would deliver superior performance.

The market over the past five years ruined the academic value of this bet. Index funds tend to win out when large-company stocks are in favor, while active managers look better when small- and midcap stocks heat up. The five years ending in 1999 represent the best five-year run for large-cap stocks in 75 years. Any fund that was not fully invested was almost certain to lose to the index.

What's more, the real benefit to indexing is not so much performance as it is capturing and compounding the incremental benefits of lower costs. Those small bits can produce a big edge when compounded over time, while the burden of active management - particularly the double layer of expenses Bogle criticizes in most fund-of-funds - impedes growth.

"Saving that expense ratio and getting it to compound in your favor is a big issue," says Roger Gibson of the Center for Fiduciary Studies in Pittsburgh. "In shorter periods, there is a lot of market noise - and the incredible environment for large-caps is market noise in this case - that clouds the picture."

Bogle and Markman have agreed to renew their bet for the next five years; to truly reflect the bet's original intent, they should keep the starting point as 1995, rather than beginning anew (as they plan to).

Ultimately, Bogleheads (as Bogle's index-investing fans are called) believe that they are right and have great returns to prove it. So do Markman's supporters. So long as the investors are happy with the results, the style that achieved them is unimportant.

Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at or at the Boston Globe, Box 2378, Boston, Mass. 02107-2378.

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