Regular readers know I'm a huge Vanguard fan boy. No organization is perfect, but Vanguard stands alone as a mutually owned mutual fund company that essentially operates at cost for the benefit of the shareholders. They've come up with a new way of taking this message to the masses recently with their “At-Cost Cafe'.”
The Cafe' is a big van driving around the country selling premium coffee for $0.26 a cup, which, coincidentally is 1/5th of the average cost of that cup of coffee across the country ($1.45 a cup). The message is that just as they're selling coffee at ridiculously cheap rates, they are selling mutual fund management at ridiculously cheap rates.
Vanguard states their average mutual fund expense ratio is 0.19% a year (pick the right funds and yours can easily be half that.) The average mutual fund expense ratio across the industry is 1.11% (which is probably far lower than it would be without Vanguard in the industry keeping the rest of them honest.) I thought this might be a good opportunity to talk about how costs matter in investing.
The Lower The ER, The Higher The Return
If you invest $30,000 a year for 30 years into investments that make 8% a year before expenses, the different between an ER of 0.19% and an ER of 1.11% is a difference of $569K ($3.54 Million vs $2.97 Million).
The Latte' Factor
If you also choose to buy your 2 cups of coffee a day at the At-Cost Cafe for $0.26 each, that means you'll save $2.38 a day, or $869 a year. If you also invested that in low-cost Vanguard funds, you'd have an extra $103K.
Lower Costs Predicts Future Out-Performance
There have been many studies that have tried to figure out how to choose mutual funds that are likely to outperform their peers in the future. The most persistent finding in these studies is that the single best predictive factor is a low expense ratio. Asebedo and Grable found that:
“Below average expense ratios led to top 30% results. This finding has significant implications for investors and financial planners. Funds that outperformed in the sample were consistently those with lower than average expense ratios. This persistence in returns held true during the stock market pre-bubble stage (1995 through 1998), the irrational exuberance stage (1999 through 2000, the cyclical bear market stage (2000 through 2002), and the significant market upturn of 2003. The finding related to expense ratios supports the conclusion of Dellva and Olson (1998) who stated, “Funds with superior performance, on average, also have lower expense ratios” (p. 100). Although past performance is no guarantee of future returns, it is reasonable to assume that this trend may continue into the future (Carpenter & Lynch, 1999)….Until further research is conducted on this topic, investors should remember the advice of Phelps and Detzel(1997) who declared “it does not appear that there is a reliable strategy for selecting funds expected to have superior future performance, other than to avoid funds with high expense ratios.”
It's easy to avoid funds with high expense ratios when shopping at Vanguard. They don't offer any. Keeping costs low is one of the key principles of investing success. Vanguard can help you do that.
What do you think? Do you invest using Vanguard mutual funds and ETFs? Why or why not?