Vanguard Is Finally Starting To Scare The Rest Of Wall St.

Vanguard is known for providing low-cost index funds whose returns are just about impossible to consistently beat and savvy investors are beginning to plow money into their funds in greater and greater amounts. Their combination of rock bottom expense ratios and hands-off, non-active stock trading investing methodology makes them incredibly attractive. I hope this means that people are beginning to take notice of what those of us in the personal finance blogosphere have been saying for years – you can’t beat a low-cost index fund in the long term.

One thing is for certain – other brokerages are taking notice. As people move money out of their high expense ratio funds and into Vanguard, these brokerages aren’t letting go easily. Fidelity just announced that they are now going to impose a 0.05% surcharge on assets in 401(k) plans managed by Fidelity that are invested in Vanguard funds. Truthfully, I’m surprised it’s that low. I’m sure over time, as the existence of this fee becomes accepted, it will increase.

401(k) plans are huge money makers for brokerages. Money comes in to the plan every time a company issues paychecks. Most plans offer only a few selections of funds (many of which may have high fees) and people tend to leave their money in a plan, even if the leave their company. This represents a very “sticky” source of income for the 401(k) managers.  Once people get invested in a 401(k), few ever leave it.

I’ve written extensively before about how these fees are relatively hidden and how they can suck away tens or hundreds of thousands of dollars from your retirement savings. I’ve also written a guide on how you can reduce those fees. As people wake up to how detrimental these fees are, they are demanding brokerages offer more lower cost funds within 401(k)s. As people shift money into those funds, the brokerages offering higher-priced funds lose revenue. Lots of revenue. They are not about to take this lying down. So, rather than try to cut their costs or improve their offers, they have opted to assess surcharges on those who invest in lower cost funds.

It’s not just 401(k) plans that are getting hit. For years, discount brokers like Schwab and E*Trade have excluded Vanguard funds from their transaction-fee-free offerings. Instead of letting their customers buy shares of Vanguard funds for no cost, their charge a higher than average transaction fee. I have experienced this myself recently. I rolled some old 401(k)s into an IRA at Schwab. I had the option to invest in Schwab’s mutual funds for free, or to invest in Vanguard funds but pay a $75 transaction fee. I opted to pay the fee because, over time, the higher expense ratios of the transaction-free funds will eclipse the $75 I had to pay now.

I think this is rather short-sighted, but Wall Street always has been more focused on short term profits than long term growth. In 2013, Vanguard had $2 trillion in assets under management. Just four years later, that amount had more than doubled to $4.5 trillion. Clearly, low cost funds are in demand.

Your Roth 401(k) Isn't Really A Roth 401(k)

Roth IRAs and Roth 401(k)s are some pretty powerful tools for retirement planning. They allow you to invest post-tax money now and withdraw both your contributions and their earning tax-free when you retire. These plans are especially great for young people who, presumably, have a long time until they retire because they can have years of tax-free earnings growth.

I participated in a company Roth 401(k) at the last couple of jobs I had. Last month, I went through the process of moving those old 401(k) plans into my IRAs. This is a process called a "roll over" and, provided the money is moved directly from the 401(k) into an IRA, there are no tax consequences.

Why would someone do this? Typically, it's to reduce fees, to get greater investment choice, and to consolidate accounts after leaving a company to make them easier to manage. As I went through this process, I discovered something:

My Roth 401(k) was not entirely a Roth 401(k).

By that, I mean not all the money in my account qualified to roll over to a Roth IRA. It turns out, employer matching contributions to a Roth 401(k) are actually made into a traditional 401(k). In other words, those contributions and earnings are NOT growing tax free.

If your 401(k) statement is anything like mine, it doesn't mention this anywhere. It was only when I went to roll over my funds into my IRA that I discovered this.

So if you have a Roth 401(k) and want to roll it over to an IRA, you'll actually have to roll it over into two IRAs - a Roth IRA for your contributions and a traditional IRA for your employer's contributions. Your 401(k) provider will be able to tell you how much of your 401(k) will go into which account.

Warren Buffett Wins His $1,000,000 Bet

Ten years ago, Warren Buffett bet hedge-fund manager Ted Seides that an investment in a passive index fund would outperform a handful of hedge funds over a 10 year period. The bet was for one million dollars, which would go to the charity of the winner's choice.

That bet has now officially ended and, no surprise, Buffett won. His index fund of choice, the Vanguard S&P 500 Index Fund Admiral Shares (VFAIX), returned a 7.1% annualized return compared to the group of hedge funds Seides chose, which returned just 2.2%.

That adds up to a big difference. Buffett's investment almost doubled in value, while the hedge funds' only increased by about 25%.

Not only that, but years ago, the wagers from the bet were invested into the B shares of Berkshire Hathaway stock. Those shares are now worth $2.2 million. That's a nice gain for the winning charity, Girls Inc. of Omaha, too.

Two Keys To Winning

The first key to winning this bet was the time frame. Ten years is a long time. In fact, after the first year of the bet, the hedge fund was actually ahead - Buffett's index fund had lost 37% while the hedge fund lost only about 24%. But as time passed, that edge evaporated.

The second key was costs. Vanguard's fund has an expense ratio of only 0.04%. For every $1,000 invested, they take $0.40 in fees. We don't know what hedge funds Seides selected, but the typical hedge fund charges 2% plus 20% of any gains. In other words,  for every $1,000 invested, they take $20 and, if they make any gains, they take an additional 20% of those gains!

Think about that. For your investment in a hedge fund to simply equal the performance of the index fund, the fund manager would have to beat the market by 22%, year after year. This simply isn't possible.

John Bogle, founder of Vanguard, investigated the results of actively managed funds, such as hedge funds, over the long term. Not one managed to achieve that sort of performance. Ever. Few could even do it for one year. John Bogle wrote an entire book proving it. He founded Vanguard based on that premise.

But stock picking is sexy...

Everyone loves a tale about someone who invested $100 in Apple or Google decades ago and is now a gajillionairre.

People also win the Powerball.

Against all odds, these things do happen.

Sorry to be the one to tell you, but neither of these things will happen to you.

That's not a judgement on your abilities or intelligence. It's simply a statistical fact.

Here's another statistical fact:

No long term, buy and hold investor has ever lost money with a low cost index fund.

Ever. Even if you bought at the peak of the market before any major crash since 1928.

See my post here for details.

If you want to grow your wealth over your lifespan, stick with low cost index funds.

Goal Update: End Of December 2017

At the end of each month, I post an update of my goals, including a brief discussion of any notable events that might have occurred during the month. The latest month's figures can always be found under the Featured menu in the menu bar at the top of the blog.

Last updated: End of December, 2017
Current value: $39,379
Change from last Month: +1,829
Percent of Goal:  36.21%

Note that the funds in this account are invested in stock, so there will be fluctuations in value that are outside my control. I never withdraw money from this account, so any dips are purely due to stock price changes.

Looking at the above chart shows I saved just over $10,000 towards the Tesla in 2017. Not bad. But I hope to increase that amount in 2018. More details to come!

Events Of Note Last Month:

My SQL courses on Udemy generated $71.74 of income. Those courses also generated $30.47 on SkillShare.

I sold my virtual currencies and made $473.17 profit.

The cash backed naked puts I sold last month ended up expiring out of the money, which is good. I wrote about this and my overall experience selling naked puts two weeks ago here.

Update On Previous Posts 

In October, I wrote about a company called M1 Finance that offers "pie-based" investing with free portfolio rebalancing. At the time I wrote that, they charged a small, completely reasonable fee for their service. Good news! They are now a completely free service! Read my updated post about them for more details.

Net Worth Update

Our net worth increased by $19,436 this month. You can see our cash reserves took a dip and our credit card balances rose slightly. This was due to holiday expenses. We did a lot of traveling from Washington to Arizona to see family and, of course, also did lots of gift buying. If you look at these monthly figures, it may seem like we are always carrying a credit card balance. We do not. I use a credit card for almost all purchases, but pay it off each week. I wrote a two part series of how to use credit cards responsibly - part one is here and part two is here. I talk about how I use them in part two. (And speaking of credit cards, remember to ask for a credit limit increase this year! It might actually improve your credit score.)

I also moved a 401(k) from an old employer into an IRA. The total value of that was about $85,000. That's why the figures below show the value of my Investments going up a bunch and my Property values dropping. Mint.com couldn't access my old 401(k) provider's website, so I had to enter it manually, which causes Mint to lump it into the Property category. The figure now shows up in the Investments category, where it belongs.

November 2017

December 2017

Here's hoping you have a prosperous and happy 2018!

If you have any questions or suggestions for topics, please drop me a line in the comments section!