New indexes and ETFs
"Smart" indexes that promise to beat the market, and exchange-traded funds: Bogle's doubts, and the case for them.
FinanceBogle ch. 14–15About 5 min: 3 reading, 2 practiceUpdated
General education, not financial advice.
- Explain how fundamental (factor) indexes differ from market-cap indexes
- Explain what an ETF is and how it differs from a classic index fund
- Recognise back-testing and why it can mislead
Common-sense investing: the case for index funds: lesson 12 of 13
- Bogle ch. 1
- The Gotrocks family 4 min
- Bogle ch. 2
- Where stock returns come from 5 min
- Bogle ch. 3
- Owning the whole market 4 min
- Bogle ch. 4
- Costs and the market return 3 min
- Bogle ch. 5
- Fund returns versus investor returns 6 min
- Bogle ch. 6
- Taxes are costs too 5 min
- Bogle ch. 7
- When future returns are lower 5 min
- Bogle ch. 8–9
- Why past winners rarely repeat 5 min
- Bogle ch. 10
- Paying for advice 5 min
- Bogle ch. 11–12
- Costs go on forever 5 min
- Bogle ch. 13
- Bonds and money-market funds 4 min
- Bogle ch. 14–15
- New indexes and ETFs 5 min
- Bogle ch. 16–18
- Graham, the arithmetic, and a plan 5 min
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Pairs with Bogle, The Little Book of Common Sense Investing (2007), chapters 14–15, "Index Funds That Promise to Beat the Market" and "The Exchange Traded Fund"
What it is
New indexes. A classic index weights each company by its market value. Some newer indexes weight by something else: sales, profits, dividends, or traits like "value" or "small size". Their promoters argue market-cap indexes hold too much of overpriced companies. These are often called fundamental, factor or "smart beta" indexes.
Bogle's view: the only way to beat the market portfolio is to depart from it, so these are active strategies in index clothing. They are usually launched after a style has done well, based on back-tests (how a rule would have done in the past), and they cost more than a classic index fund.
ETFs. An exchange-traded fund is a fund whose shares trade on a stock exchange all day, like a company's shares. The first U.S. ETF, from the early 1990s, tracked the S&P 500. Bogle has no quarrel with a broad, low-cost ETF held for the long run. His complaint is about ETFs built for trading, or for narrow slices of the market, which bring back the costs, taxes and timing mistakes of earlier lessons.
Quick check
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What is a back-test?
- A back-test is hypothetical, run on past data
Show answer
A calculation of how a strategy would have performed in the past. It applies today's rule to old data.
Why it matters
Investors now face thousands of index products. Knowing the difference between owning the whole market and following a rule that departs from it helps you see what you're actually buying.
Worked example
Why back-tests flatter. Suppose researchers test 20 different rules on the last 30 years of data. By chance alone, some will look good. The best of the 20 gets launched as a new index, advertised with its excellent "history". But that history was chosen because it looked best, which is the same trap as picking last year's top fund (see Why past winners rarely repeat).
Bogle adds the arithmetic: in his 2007 figures, the back-tested advantage of these strategies was 1–2 points a year, while their expense ratios ran from about 0.28% to 1.89%, before any extra trading costs and taxes.
Common mistake
Assuming "index" means "low cost and the whole market". An index can be narrow, frequently changed, or built to follow an active strategy. Check what it holds, how often it trades, and what it costs.
Key terms
- ETF
- exchange-traded fund: a fund whose shares trade on an exchange during the day
- fundamental index
- an index weighted by measures like sales or dividends, not market value
- factor ("smart beta")
- a trait such as value, size or momentum that a strategy tilts toward
- back-test
- applying a rule to past data to see how it would have done
- data mining
- searching past data until something looks good, which may not last
Practise the key terms
Tap a card to turn it over. 5 cards.
| Front | Back |
|---|---|
| ETF | exchange-traded fund: a fund whose shares trade on an exchange during the day |
| fundamental index | an index weighted by measures like sales or dividends, not market value |
| factor ("smart beta") | a trait such as value, size or momentum that a strategy tilts toward |
| back-test | applying a rule to past data to see how it would have done |
| data mining | searching past data until something looks good, which may not last |
Practice
Sort it
In Bogle's terms: closer to "owning the whole market", or "departing from it"?
A broad total-market ETF held for 20 years
Broad, low cost, held.Show answer
Owning the whole market. Broad, low cost, held.
An index weighted by dividends
It tilts away from market weights.Show answer
Departing from it. It tilts away from market weights.
A single-industry ETF bought for a quick trade
Narrow, and traded.Show answer
Departing from it. Narrow, and traded.
A cap-weighted total-market index fund
The classic index fund.Show answer
Owning the whole market. The classic index fund.
Quick quiz
Tap an answer to check it.
Why does Bogle distrust new indexes advertised with excellent back-tested records?
- He doesn't say that; the problem is selection and reversion
Show answer
Strategies tend to be launched after they've done well, and past success may not repeat. Data mining and reversion to the mean.
What is Bogle's main objection to ETFs?
- Broad ETFs can
Show answer
That many are used for trading or narrow bets, which raises costs and timing mistakes. The vehicle is fine; the trading is the problem.
The other view
Many researchers disagree with Bogle on factors. Some long-studied tilts (value and small size, for example) have earned extra returns over long periods in historical data, and academic models explain them either as rewards for extra risk or as lasting behavioural patterns. Others find these premiums have shrunk or vanished after being published. The debate is open.
ETFs have also grown far beyond Bogle's day: he counted about $410 billion in ETFs in 2006, and the U.S. Investment Company Institute reports that total net assets of ETFs (U.S.-registered funds, which it covers) passed $13 trillion in 2025. Many are broad, very low-cost index funds held for the long term, the use Bogle himself accepted.
Last checked: 27 October 2026.
In short
- New "smart" indexes depart from the market portfolio, so Bogle treats them as active strategies.
- Back-tests are chosen with hindsight and can mislead.
- ETFs are a vehicle: broad and held can match a classic index fund; narrow and traded can't.
- Researchers still debate whether factor tilts will keep paying.
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According to Bogle, what is the only way to beat the market portfolio?
Show answer
To depart from it, which is what active strategies, including new indexes, do.
What makes an ETF different from a classic index fund?
Show answer
Its shares trade on an exchange throughout the day.
Why can the "best" back-tested strategy disappoint after launch?
Show answer
It was chosen because it looked best on past data, partly by chance, and that may not repeat.
Further reading
- John C. Bogle, The Little Book of Common Sense Investing (John Wiley & Sons, 2007), chapters 14–15.
- Investor.gov: Smart Beta, Quant Funds and other Non-Traditional Index Funds, the U.S. SEC's plain-language page.
- Investment Company Institute, "ICI Fact Book Showcases Broad Array of Fund Industry Statistics" (April 2026).
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