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.