John Bogle Is Wrong About ETFs

John Bogle is wrong.

The founder of the index fund giant Vanguard took to the editorial pages of the Wall Street Journal just before the weekend to denounce exchange-traded funds for "their overlay of costs, limited diversification and short-term trading strategies."

These ETFs, which are booming in popularity among investors, trade all day on the market like regular shares, and they invest their money in a passive basket of stocks. Bogle said ETFs were inferior to regular index funds -- first pioneered by Vanguard -- where you invest directly with the company and which are traded just once a day. These, he argued, offer inexpensive diversification and a long-term "buy and hold" strategy.

(Jim Cramer, of course, also criticized ETFs last week. His case seems to be that you're better off buying individual stocks. That raises a different set of issues than Bogle did. You're either comfortable buying individual stocks, or you're not.)

I don't mean to beat up on Bogle. He is, or should be, a hero to every average investor. His low-cost index funds helped drive down expenses across the industry, raising investment returns for many. But his column, which has sent ripples across the financial media, misses the point. Exchange-traded index funds are only inferior to regular index funds if you use them incorrectly.

Why? There are many kinds of investors. Let's say you want to follow Bogle's strategy, which is to spread your money across the market in an index fund and forget about it. In that case, an ordinary index fund may well be your best bet. Your costs are low. You can get widely diversified: In fact, if you use the (VTSMX Quote)Vanguard Total Stock Market Index fund (VTSMX), you're spread across the entire market. You pay no broker's fees, provided you buy the fund direct from Vanguard. It's a good strategy.

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