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Wednesday, April 25, 2018

Stop Worshiping Vanguard Funds Already!


In the personal finance world, it’s very well known that mutual fund expenses can significantly reduce your real returns over the typical 20 to 30 year period that most people have for retirement savings. Vanguard, the company that pretty much invented low cost mutual fund investing, has achieved an almost cult-like status among the personal finance blogging community due to their ultra-low expenses ratios, which are around 0.04%. And, compared to funds that charge 1% or higher, that is a steep discount that can save you tens of thousands of dollars over your investment time frame.

But let’s try to cut back on drinking the Vanguard Kool-Aid, ok?

Yes, Vanguard is great for saving investors money. Yes, they were the first to introduce low costs index funds to the masses. Yes, John C. Bogle was a wise man.

But does Vanguard still deserve the automatic recommendation that many people give it? I’m not sure it does anymore.

You Could Do Worse Than Vanguard. But You Could Do Better, Too

Look, choosing a Vanguard fund will probably never be a flat out bad choice. It’s well established that index funds do better in the long term than actively managed funds, that they have less turnover, which results in less of a tax bill (if you are investing outside of a tax-preferred plan such as an IRA), and that they have some of the lowest fees of all the mutual funds out there.

However, index funds have become something of a commodity now and when something becomes a commodity, competition reaches a peak and differences between various offerings become almost negligible. Think gasoline or milk or multivitamins. It doesn’t really matter which brand you buy because they are all pretty much the same.

Index funds have become commoditized. Just about every broker offers their own version and because they all seek to mirror a particular benchmark, there isn’t much to differentiate them other than price. For years, that was what set Vanguard apart from other funds, but that advantage is now gone.

I've written before about how many brokerages are now charging a surcharge to invest in Vanguard funds. This can either come as a flat percentage surcharge, as Fidelity has implemented, or a higher transaction fee, like Schwab charges. So it’s time to look for alternatives to Vanguard. I was quite surprised to see they are easy to find.

A Comparison

Let’s compare the granddaddy of Vanguard funds – the Vanguard S&P 500 Index Fund Admiralty shares (VFIAX) with Schwab’s version of the same fund – The Schwab S&P 500 Index Fund (SWPPX). (I’m picking the Vanguard Admiralty shares because, although it requires a $10,000 minimum investment, that is the one that gets you the ultra-low 0.04% expense ratio. The non-Admiralty shares have a higher 0.14% expense ratio.)

The expense ratio is actually lower for the Schwab fund: 0.03% versus 0.04%. Turnover is also lower at 2% versus Vanguard’s 3%. Both funds limit frequent traders, although Vanguard has stricter rules. If you sell shares of the Vanguard fund, you cannot buy more shares within 30 days of the sale. The Schwab fund, according to the prospectus, MAY limit purchases of traders who buy and sell the fund multiple times within 60 days, but the limit will extend for 90 days from the last roundtrip buy / sell. VFAIX has a $10,000 minimum investment. SWPPX has a $1 minimum investment (however, as of Oct 2017, you must be a Schwab customer to purchase shares). And of course, there are also the higher transaction fees some brokerages are now charging for Vanguard funds.

VFIAXSWPPX
Min. Purchase$10,000$1
Expense Ratio0.04%0.03%
Turnover3%2%
Total Assets$400 Billion$32 Billion

So far, I don’t see anything that gives Vanguard a huge edge. If anything, I would say the Schwab fund is looking slightly more attractive at this point.

How About Performance?




click to enlarge

As you might expect, performance is just about identical and both funds mirror the S&P 500 perfectly.

What About Holdings?



The top 5 holdings of each fund differ only in the fourth and fifth spots. This seems a little strange because both funds are supposed to have holdings in the same proportion that the S&P 500 is comprised of. But for the most part, their holdings are identical as well.

What About Distributions?

Here, at last, there is a significant difference - the frequency at which they distribute dividends and capital gains. The Schwab fund does it yearly while Vanguard does it quarterly. I suppose if you were retired and looking for cash flow, then the Vanguard fund would be the better choice.


Although the distribution amounts are different, when you look at dividend yield, the distribution as a percentage of asset price, the two are very close: 1.84% for Vanguard and 1.76% for Schwab. That's a 0.08% edge to Vanguard. But remember they have a 0.01% higher expense ratio, so the true edge is just 0.07%. On a $10,000 investment, that works out to an extra $212 over 30 years. That's less than peanuts. Peanut shells.

Leave The Cult

So there you have it. Vanguard, without a doubt, changed the mutual fund industry with their low cost fund offerings. Their influence was, and still is, huge and consumers have benefited from it. But other companies have learned that lesson and offer funds that are just as good as, if not better than, Vanguard. It's time for an intervention. Stop the blind devotion to Vanguard and start exploring other comparable funds.

14 comments:

  1. It is good to find alternatives. But, Vanguard forced them to do so. They did not do it for investors, I believe the motivation was to capture the market share since public started to know what high expenses do to their investments in long term.

    Question is, Once Schwabb or any other Fund houses reaches fund sizes level where Vanguard is, will they continue to offer low expense funds or start following usual corporate "for profit" path. It is historically seen when companies capture the targeted market or get what they want, they change. Summarizing, may be it is just a capturing the market trick, once achieved, go back to profit hunting(it is in their blood).

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  2. A nice post and certainly worth pointing out that economic alternatives to Vanguard do exist. I personally like Schwab as a close second to Vanguard. There is one major point though that is left out in this post that is part of the drive behind the so-called "cult of Vanguard". From Investopedia:

    "Vanguard has a fairly unique structure in terms of investment management companies. The company is owned by its funds. The company’s different funds are then owned by the shareholders. Thus, the shareholders are the true owners of Vanguard. The company has no outside investors other than its shareholders. Most of the major investment firms are publicly traded."

    This reduces potential conflicts of interest between the investment firms, and your average investor. Schwab, Fidelity, BlackRock, etc...they do not have this structure that fundamentally puts the average investor first. I'm not badmouthing the other firms, not at all, but it's a fact that needs to be added to this conversation.

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    1. That's a very good point! I forgot about that.

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  3. group think in anything based on independence, like the financial type, is ironic. go ahead and index: gotta make sure you're weighted nicely to the oil drillers, miners, and banks, which are all in the toilet the past 10 years.

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  4. You might be right but when you have your portfolio parked in Vanguatc for a jillion years, not much motivation to move plus you can buy almost any other outside fund from Vanguard www.theretirementspt.com

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  5. Not a big fan of index funds. There are plenty of funds out there that can beat the index. All US-focused American Funds have beaten the Vanguard S&P 500 in its lifetime, for example. I'd also avoid buying small cap index funds. These type of funds blindly invest in bad companies. You are better off buying an actively managed fund with a great track record.

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    1. I find that very difficult to believe. Which funds of theirs do you consider "US-focused?" Every fund I looked at had some international exposure. Please provide the trading symbols for the ones that beat Vanguard S&P 500 over its lifetime.

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    2. Sure AMCPX, AGTHX, AWSHX.. or better yet, just google "American vs Vanguard".

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    3. Not even close. This is too detailed for a comment. I'll make a separate post about it that will go up on Wednesday.

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    4. OK, "not even close" may be an overstatement, but it's not as cut and dried as this comment implied. Details on Wednesday.

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  6. I invest my personal accounts at Schwab. I have a Rollover IRA from my previous employer at Vanguard, but I'm going to be switching brokers because I can't stand the platform. I like a few of their mutual funds and ETFs, but many other brokerages have similar funds.

    I appreciate Vanguard for helping drive investing costs down over the last 30 years, but I'm glad your opinion got featured in Rockstar. 80% (my opinion) of online investment advice is to automatically go with Vanguard.

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  7. Schwab and Fidelity have "loss leaders". Index funds that are lower cost than Vanguard. Wooing customers. The problem is many of their other products (they really want to sell you) are much more expensive. I'll stick with Vanguard. They run their business differently. All the others are "for profit". Many paths.

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  8. Choose the lowest cost fund that achieves your investment goals. It's not that hard to figure out.

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  9. Pick the lowest cost fund that meets your investing goals. It's not that hard to figure out.

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