The Vanguard Effect on ETF and Mutual Fund Expenses

The following chart taken from this Bloomberg article by Eric Balchunas shows the drastic difference in expense ratios when Vanguard has an offering in an asset class or not.

Like Walmart arriving in a new town, the entry of Vanguard into a particular investment area causes a collective gnashing of teeth as other fund managers are forced to drop their prices to compete. That dynamic is borne out in the table below, which shows the cheapest ETF fees for products that do or do not have a Vanguard-provided equivalent.

This is the “Vanguard Effect”. Here’s my version of explaining how it works:

• When Vanguard competes in an area, the expense ratios across the board are much, much lower.
• Note that the cheapest expense ratios you see in those asset classes not necessarily from Vanguard itself. It is often from a competitor like Charles Schwab.
• When Vanguard doesn’t compete, the expense ratios are much higher.
• In those no-Vanguard asset classes, the competitor won’t lower prices just because they can. They’ll keep the profit margin as high as they can, as they are bound to serving the business owners as well as ETF share owners. The gap between what they can charge and what they must charge goes to business profits. They aren’t evil, they are just trying to serve their two masters.
• At Vanguard, the business owner is the ETF share owner. (Vanguard uses the term “client-owned”.) For them, the most efficient way to pass on potential profits is to keep expenses as low as possible.

This is why you see DIY investors always wish Vanguard would offer something like an International Small Value ETF or a US Micro Cap ETF. By simply entering the ring, even the expense ratios of the ETFs we already hold from other providers will go down.