Protection Money

Jonathan Clements

VANGUARD GROUP is my favorite fund company—and the place where I now keep all my investment dollars. There’s no mystery why: Among mutual fund companies, Vanguard has long been not only the biggest champion of index funds, but also the firm with the lowest annual fund expenses.

Except that’s no longer the case.

Fidelity Investments, BlackRock’s iShares and Charles Schwab have all muscled onto Vanguard’s turf, offering index funds with lower annual expenses. This is obviously a marketing ploy: By offering cut-rate deals on select index funds, they hope investors will also buy some of their pricier merchandise.

Still, this is a potential bonanza for investors, who can now invest at extraordinarily low cost. Suppose you were aiming to build a global balanced portfolio, with 40% bonds and 60% stocks. The 60% stock portion is split so you have 40% in the U.S. and 20% overseas, including a 4% allocation to emerging markets. Here’s how much you would pay at four major fund companies:

Fidelity Investments


Charles Schwab

Vanguard Group

The three Fidelity funds are mutual funds, which means you can buy them directly from Fidelity, with no additional cost. All three funds require a $10,000 minimum investment. The other funds listed are exchange-traded index funds, so buyers would likely lose a little to trading spreads and perhaps commissions. In the case of the three Vanguard funds and three of the four Schwab funds, there are corresponding mutual funds with the same annual expenses. The similar-cost Vanguard funds have $10,000 investment minimums, while the Schwab funds have no required minimum.

Keep in mind that expenses aren’t the sole driver of differences in index fund performance. Funds can also help performance by skillfully replicating their target index or by making money from securities lending.

But forget those issues. Based solely on expenses, it looks like Vanguard wouldn’t be anybody’s first choice. And yet I’m not about to move my money elsewhere.

Why not? Vanguard is effectively owned by the shareholders of its funds, and it benefits those shareholders by operating its funds at cost. If Vanguard is operating at cost, all of these other firms are barely breaking even and possibly losing money. How long will these firms—which, unlike Vanguard, are profit-making entities—be willing to operate that way?

Maybe it’s forever. But maybe it’s only until the investment dollars stop pouring in, at which point these firms might decide it’s time to make a little money off the assets they’ve gathered. At that juncture, shareholders will face a tough choice: They can either stick with funds that are no longer dirt cheap—or they can move to lower-cost funds. The problem: Selling could trigger capital gains taxes if investors own their index funds in a regular taxable account. By contrast, selling in a retirement account wouldn’t trigger taxes, but it would be a hassle—and investors could incur modest transaction costs and perhaps find themselves out of the market for a few days.

Or these investors could just stick with Vanguard, where there shouldn’t be any sudden price hikes. Right now, on our hypothetical balanced portfolio, that would mean paying as much as $15 a year extra for every $100,000 invested. I think of it as protection money—and it strikes me as a small price to pay.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

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