When Did Index Funds Start? A Look at Their Origins

Index funds represent a straightforward investment approach, allowing individuals to invest in a broad market segment rather than selecting individual securities. This strategy involves creating a portfolio designed to mirror the performance of a specific market index, such as a major stock market benchmark. By passively tracking an index, these funds aim to provide market-like returns without the complexities and higher costs often associated with actively managed investments.

The Theoretical Foundation

The emergence of index funds was influenced by academic theories challenging traditional investment practices. A central concept was the Efficient Market Hypothesis (EMH), developed by economist Eugene Fama in the mid-1960s. This hypothesis posits that market prices already reflect all available information, making it difficult for any investor to consistently achieve returns that surpass the overall market after accounting for risk and costs.

This theoretical framework implied that active management, which seeks to outperform the market through stock picking or timing, faced a substantial hurdle. Nobel laureate Paul Samuelson also contributed, arguing that in competitive markets, properly anticipated prices tend to fluctuate randomly, further supporting the notion that consistently beating the market is improbable. These academic insights laid the groundwork for a new investment philosophy, suggesting that a more effective approach for many investors might be to simply track the market.

The Inaugural Index Fund

The practical application of these academic theories culminated in the launch of the first index fund made available to the general public. John C. Bogle, who founded The Vanguard Group in 1974, spearheaded this initiative. On December 31, 1975, Vanguard introduced the First Index Investment Trust, which was later renamed the Vanguard 500 Index Fund.

This pioneering fund was designed to replicate the performance of the Standard & Poor’s 500 (S&P 500) index, a widely recognized benchmark of large U.S. company stocks. Despite its design, the fund faced skepticism and resistance from the financial industry. Its initial public offering raised only about $11 million, far short of the $150 million target, leading some critics to deride it as “Bogle’s Folly.” While institutional index funds had existed for a few years prior, offered by firms like Wells Fargo and American National Bank to large clients, Vanguard’s offering marked the first time individual investors could access such a product.

Early Adoption and Evolution

Following its introduction, the First Index Investment Trust experienced a slow start, struggling to gain acceptance in a financial landscape dominated by active management. The fund’s low initial fundraising reflected skepticism and unfamiliarity with passive investing. Additionally, the lack of commissions for brokers meant there was little incentive to promote the product to clients.

Despite these early hurdles, the concept of index investing gradually gained traction. Investors began to recognize the benefits of the fund’s low costs and its ability to consistently deliver competitive returns, often outperforming many actively managed funds over the long term. By 1985, assets under management for index funds had grown to approximately $511 million from their $11 million beginning. This success led Vanguard to introduce additional index funds, expanding its offerings and solidifying the concept of a diversified index fund family. Other financial institutions, observing the nascent success, began to follow suit, with firms like Fidelity launching their own S&P 500 index funds in the late 1980s.