When Were Index Funds Invented? A Brief History

Index funds have transformed how individuals and institutions approach investing, becoming a widely adopted method for diversified market exposure. These investment vehicles mirror the performance of a specific market index, such as the S&P 500, rather than attempting to outperform it through active stock picking. They provide broad market participation, often at lower costs compared to actively managed funds, making investing more accessible. This approach has a rich history, rooted in academic theories and pioneering financial efforts.

The Theoretical Foundation

The intellectual groundwork for index funds emerged from advancements in financial economics during the mid-20th century. A primary concept was the Efficient Market Hypothesis (EMH), developed by economist Eugene Fama. This theory posits that financial markets are highly efficient, meaning asset prices fully and rapidly reflect all available information, making it challenging to consistently achieve returns exceeding the market average through analytical efforts or timing strategies.

Another foundational theory was Modern Portfolio Theory (MPT), introduced by Harry Markowitz in his 1952 paper, “Portfolio Selection.” MPT provided a mathematical framework for constructing investment portfolios that optimize the balance between risk and expected return. It emphasized diversification, illustrating that combining various assets with different risk and return profiles could reduce overall portfolio risk without sacrificing potential returns. These academic insights collectively laid the conceptual basis, suggesting a passive, market-matching investment strategy could be prudent and effective.

The First Practical Implementations

The theoretical underpinnings began to translate into practical applications in the early 1970s. The earliest institutional index funds served large clients, primarily pension funds. In 1971, Wells Fargo launched an index fund for the Samsonite Corporation’s pension plan, designed to track stocks on the New York Stock Exchange. This initial effort proved complex due to its equal-weighted approach and frequent rebalancing.

Shortly thereafter, in 1973, Wells Fargo, with John McQuown and David G. Booth, and American National Bank in Chicago, with Rex Sinquefield, established some of the first S&P 500 index funds for institutional investors. These funds were not available to the public but marked significant steps toward passive investing. The pivotal moment for individual investors arrived in 1976 when John C. Bogle, founder of The Vanguard Group, launched the First Index Investment Trust. This fund, later renamed the Vanguard 500 Index Fund, was the first index mutual fund accessible to the public, tracking the S&P 500.

Early Growth and Recognition

Despite academic backing and initial institutional adoption, the broader investment community initially received index funds lukewarmly, even with derision. John Bogle’s First Index Investment Trust, launched with $11.3 million, was mocked as “Bogle’s Folly” and criticized as “un-American.” The prevailing financial industry model was geared toward active management, where fund managers sought to outperform the market through stock selection and timing. Critics often argued investors would not be satisfied with merely “average” market returns.

Despite initial skepticism, early advocates championed the benefits of index funds, focusing on their broad diversification and low operating costs. Unlike actively managed funds that incurred substantial research and trading expenses, index funds, by mirroring an index, operated with significantly lower expense ratios. This cost efficiency often translated into better long-term returns for investors, especially after fees. Public-sector pension funds were among the early adopters, recognizing the efficiency of passive strategies. Growth was slow initially, with the Vanguard fund reaching only $511 million by 1985, but laid the groundwork for future acceptance and expansion into tracking different market segments.