Tuesday, April 10, 2012

Why Vanguard?

It has occurred to me that I might sound like a Vanguard shill or salesman to those of you who do not have experience with a number of mutual fund and brokerage companies, including Vanguard. I assure you that I receive no benefit of any kind in recommending Vanguard funds, other than the satisfaction of seeing my friends and family benefiting from using the best mutual fund company on the planet (there I go again!). So, what is so special about Vanguard?

I’ve invested at a number of other mutual fund and brokerage companies, including Fidelity, Schwab, Interactive Brokers, and Wells Fargo (WellsTrade), not to mention a number of brokerage firms I used many years ago. I still have accounts at some of these firms, but if I wanted to really simplify my investing life, I would just use Vanguard.

The most obvious reason to use Vanguard is that it has the broadest selection of low-cost mutual funds of any mutual fund company. Other companies may offer a few low-cost index funds that are competitive with Vanguard, but none offers the range of low-cost funds that Vanguard does.

For example, Schwab offers a few low-cost stock and bond index funds, but nowhere near as many as Vanguard. I used to recommend Schwab for young investors without the minimum $3,000 investment required for most Vanguard funds. Now that Vanguard has lowered its minimum investment to $1,000 for its Target Retirement funds, I now recommend that young investors just save up $1,000, then invest in a Vanguard Target Retirement fund.

Fidelity has some low-cost stock and bond index funds (Spartan funds), but the minimum investment for these funds is $10,000 (compared to $3,000 for most funds at Vanguard), and the breadth of low-cost fund choices is not comparable to that of Vanguard. Some of Fidelity’s Spartan funds are good choices if they are offered in your 401k or 403b plan, since the minimum investment does not apply (the minimum investments are met by the company by pooling the assets of the plan participants).

To see another blogger’s comparison of Vanguard, Fidelity and Schwab mutual funds, see the Oblivious Investor blog post The Best (Low-Cost) Index Funds. The post is somewhat old, so things have changed a bit since it was written, but you still might be interested in reading it. I just happened to find the Oblivious Investor blog post in doing a little web research for this blog post.

Vanguard has been offering low-cost index funds for much longer than its competitors; I trust them more. Some competitors are improving, but Vanguard still has a huge lead.

Vanguard’s unique ownership structure is the main reason it is able to keep costs so low. Vanguard is a not-for-profit company; it is owned by the Vanguard funds, which are owned by its clients (like you and me). Therefore Vanguard does not have to worry about making a profit for its shareholders or private owners, and can pass on any profits and cost savings to its clients. As stated by David Swenson, the highly-respected chief investment officer of Yale University, Vanguard’s interests are aligned with the interests of investors, and this is very rare for financial institutions.

By contrast, privately owned companies like Fidelity, or publicly-traded companies like Schwab and T. Rowe Price must generate profits for their owners. Those profits come directly out of the pockets of their clients. Their interest in making a profit is not aligned with your interest in keeping your investment costs low.

To read more about why low costs are so important, see my blog post Costs Matter.

Another reason to use Vanguard, especially for tax-advantaged accounts (e.g., IRA, Roth IRA, 401k/403b, etc.), is that it has what I consider to be the best all-in-one funds: the Target Retirement and LifeStrategy funds. The underlying funds held by most of these all-in-one funds are three, low-cost index funds representing a simple asset mix of three asset classes: total US stocks, total international stocks, and total US bonds. All-in-one funds from other companies are much more complex and more expensive, typically investing in many higher-cost, actively managed funds. Vanguard’s approach is simple, low-cost, and consistent with best practices in portfolio construction.

Vanguard makes it very easy to investigate its mutual funds. Simply navigate to the Vanguard website for personal investors, then click Research Funds & Stocks. This will take you directly to the Vanguard Funds page. There you will see various categories listed, such as Retirement, College, Any goal, and All mutual funds.

On the All mutual funds page you can filter your selection in many ways, such as Stocks (U.S.), Bonds, or International (stocks). Clicking on a fund name takes you directly to the Overview page for the fund, which displays some of the most important information about the fund. I especially like that the expense ratio (ER) is prominently displayed near the top of the Overview page; since keeping costs low is one of the primary things you can control in making your investment choices, knowing the ER of a fund is critical.

So yes, I write a lot about Vanguard mutual funds--because I think Vanguard is the best mutual fund company. If you want to invest in mutual funds in your IRA or taxable (individual, joint or trust) account, I recommend Vanguard. If your employer-sponsored retirement plan (401k, 403b, etc.) offers Vanguard funds, chances are they are among the best funds, if not the best funds offered. No, I am not a shill for Vanguard; I just want you to get the best deal possible when investing in mutual funds.

5 comments:

slug said...

What do you think about the Schwab ETF's that you can trade commission-free and have lower expense ratios than Vanguard and Fidelity? It seems like a nice low cost option to me.

Kevin said...

@Slug, I think the Schwab ETFs (Exchange Traded Funds) are fine for someone who wants to use ETFs. I opened a small Schwab account just so I could get some experience with their ETFs.

My youngest daughter opened a Schwab account a couple of years ago, in which she uses the Total Stock and Total International mutual funds for the core, and then some of the ETFs to tilt to small and value. This was a good option for her since she started with a small amount and added in small increments. Although you also can trade Vanguard ETFs for free at Vanguard, the comparable Schwab ETFs have lower per-share prices, so you can buy in smaller increments. Also, Vanguard charges a $20 annual fee for a brokerage account (not a mutual fund account) unless you have enough money with them.

The Expense Ratios (ERs) are so low for all of the competitive ETFs at Vanguard, Schwab and Fidelity that it just won't make that much difference. The differences between the Schwab and Vanguard ETFs is inconsequential, e.g., 0.06% for Schwab's total US market ETF vs. 0.07% for Vanguard's. The ERs of some of Vanguards ETFs are actually slightly lower. It's just not an issue.

Also consider that expense ratios are not the only cost. Schwab ETFs generally have lower trading volumes than Vanguard ETFs, so the bid/ask spread can be larger, which increases your costs. The premium or discount at which the ETF trades relative to NAV (Net Asset Value) also affects costs.

Finally, as with low-cost mutual funds, Vanguard offers a broader range of ETFs; e.g., Schwab does not have a small-cap value ETF. Schwab's international ETF does not include emerging markets (Vanguard has one that does), so you must use two ETFs at Schwab to cover the total international market.

Mutual funds are better for most investors since they are simpler to buy and sell, so that's what I focus more on in this blog.

Thanks for the comment!

Kevin

Anonymous said...

Hi Kevin:

In 1986 we moved all our securities from Merrill Lynch to Vanguard. IT WAS THE BEST FINANCIAL DECISION WE EVER MADE.

You are providing a very valuable service for your readers.

Thank you.

Taylor Larimore
Miami, Florida

Anonymous said...

Hi Kevin - you're helping me think about what to do with my accounts which are now at Fidelity. But I'm perplexed by your statement in this blog post that mutual funds are easier to buy and sell. ETF's trade like stocks, so it's a no-brainer to buy and sell them. Plus you know their value intra-day, no waiting for nav calculations. Maybe not a big deal, but true still. But the big reason for ETF's (and something a Vanguard rep confirmed me recently on the phone as to why Vanguard is making such a big ETF push) is tax efficiency. ETF's held in a taxable account will make you much happier at tax time than will mutual funds, especially actively managed ones. True, Vanguard specializes in passive funds, so maybe not such a big deal, but generally speaking, ETF's offer more tax efficiencies than mutual funds, so it's something to consider.

Kevin said...

If you are comfortable trading ETFs, then go for it. The main reason I said they are more complicated to buy and sell is that you have to make several decisions to do so. First, you must decide on whether to use a market order or limit order. If you use a limit order, you have to decide on a limit price, then if your order doesn't execute, you have to decide on a new limit price. With a mutual fund, you only have one choice; just enter your order.

If you are tax loss harvesting with ETFs, you have to do two transactions, and the market may move against you in between transactions, so you risk losing a bit to this "friction". With mutual funds, you can just do one exchange between funds, knowing both ends of the transaction are executed at NAV.

Yes, you know ETFs market value intra-day, but there is an unknown premium or discount to NAV, so there is a risk that you could lose a bit here; of course you could gain a bit if you're lucky--it's just an additional unknown.

Since most Vanguard ETFs are just a different share class of the corresponding mutual fund, they are no more tax efficient than the corresponding Vanguard mutual fund. Having an ETF share class does improve the tax efficiency of all share classes of the fund, so it's a good thing Vanguard provides the ETF share classes.

It's true that non-Vanguard ETFs generally are more tax efficient than a comparable mutual fund. Of course if most of your investments are in tax-advantaged accounts (IRA, 401k, 403b, etc.), this is not a consideration.

I wouldn't compare ETFs to actively managed funds. Using a passively managed (index) mutual fund is likely to be more tax efficient than a comparable actively managed fund.

Thanks for the comments!

Kevin