Chart: Vanguard Low-Cost Philosophy At Work

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costsmatterThe debate between active and passive investing has come full circle. We’ve officially gone from “index funds will never work!” to “index funds are working too well, it can’t keep on going”. Check out the Forbes article Is Vanguard Too Successful?

Passive vs. active is just a smokescreen. You know what really works? Low costs! There was a big hubbub when Morningstar admitted that expense ratios were a better predictor of performance than their much-advertised star ratings system. Vanguard has many successful actively-managed funds and that is due both to good managers and low costs. Wellington, Wellesley, PrimeCap, they all have expense ratios that are fractions of their competitors.

In addition, what makes Vanguard special is their inherent, longstanding commitment to low costs. Look at how the asset-weighted average expense ratio of all Vanguard funds (including actively-managed funds) has dropped since their inception:


Providers like Schwab and iShares all have some ETFs that are very low cost now, but they also have a duty to maximize shareholder value. If you’re a for-profit company and you think you can keep prices the same even as your assets rise, you do that. The very structure of Vanguard states that the investors themselves own the funds, which means they naturally pass on any savings onto the retail investor. (I do believe that the recent competition is good however and it keeps everyone, including Vanguard, on their toes.)

The “at-cost” investing structure is why the majority of my assets are invested in Vanguard funds and ETFs.

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  1. Hello there,

    While I understand that your blog is generally geared towards simple, long-term guidance, I did want to mention that sometimes liquidity also matters, particularly if your long:term investment strategy includes using options.

    While perhaps not appropriate for every investor, I appreciate the much deeper liquidity of an instrument like SPY over some of the other slightly cheaper funds (on an absolute basis.) I can leverage tighter spreads on options strategies, saving investors money.

    With SPY, one can take advantage of mini-options to hedge exposure or attempt to collect extra income with smaller positions, although I wonder if that particular style of contract is being phased-out, probably since they’re not widely-used. (I find it hilarious that I’ve owned 100% of the open interest in some strike/expiry combinations.)

    • Good points Jeff, but what you are doing is not passive, and the costs collectively add up. Each option you sell has a commission, and a bid ask spread which eats into your return. Can that approach work? Certainly if you know what your doing, but its not for anyone looking to invest/save and forget about it for years.

  2. I also have a substantial amount of my assets in Vanguard. Lately with their popularity, I’ve been wondering if there is any concern with having “too many eggs in one basket” with just one brokerage. I realize SIPC coverage of $500k ($250k cash) covers some of this risk. I think anyone with financial acumen would realize these limits are low. A $500k portfolio at the beginning of retirement may not be enough for some.

    I realize the risk of Vanguard imploding is virtually non-existent. But some also thought the housing market would never stop growing either. Is it worth spreading some money around various brokerages to avoid this risk? Or do Vanguard’s superior products (in the eyes of some) negate this risk?

    • This is a good topic, one that I would also like a definitive answer to. I would never assume that any company could never fail.

      From my understanding (which I’m not an expert, please correct me if I am wrong), I feel that having all your assets with one brokerage does not matter (with a caveat).

      First look at a bank’s savings account example. The reason you need FDIC insurance and you shouldn’t put all your money in one bank is because the bank is taking your money and investing it somewhere that you don’t know. If it makes bad investments, you could lose your money except for the FDIC insured portion.

      However, with stocks or stock funds, the brokerage cannot take your money and invest it elsewhere. The underlying assets stay invested in what you invested in. And the underlying assets (in general) are outside of Vanguard. So even if Vanguard fails, the underlying assets don’t (e.g. the S&P500 companies). The most you would lose is whatever Vanguard kept as cash for liquidity, maybe 1%.

      The caveat is that this excludes Vanguard money market funds or other funds that Vanguard does actually take the money and invest in other areas without your control. Those you could lose.

    • Even if vanguard implodes, your securities there shouldn’t be affected. It is illegal for vanguard to use your assets as their own. They legally need to be seperated. I suppose its possible for Vanguard, or any entity, to break the law and post your assets as collateral etc. but I would think this highly unlikely.

      There would be nothing wrong with diversifying, however, the only way you would be hurt by “having all your eggs” in one basket is if vanguard imploded and was acting unethically/illegally like Enron.

    • The structure and regulation of mutual funds makes it extremely unlikely that one would be able to pull off a Madoff-style fraud. The SEC requires that quarterly holdings be disclosed, and also that the management and custodian of the holdings be separate. For instance, while Vanguard manages (or chooses a separate manager) for their funds, JP Morgan is the custodian for all the securities that they hold. In order to misuse the securities, Vanguard /and/ JP Morgan would have to collude.

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