By Dr. James M. Dahle, WCI Founder
If you've been around this blog for very long at all, you've probably noticed that I spend a lot of time discussing Vanguard, to the exclusion of other mutual fund and brokerage companies. If you don't know why Vanguard is so special (and my usual default choice when people ask where to invest), this post is for you. In 2020, 9 years after originally writing this post, the time has finally come to update it. It needed precious little update.
Vanguard was founded in 1975 by the late John C. (Jack) Bogle, being named after Admiral Horatio Nelson's Flagship at the Battle of the Nile in 1798. It was founded after a dispute arose between Bogle and the members of the board of Wellington Management Company. He was on the board of the Wellington Management Company, but after irreconcilable differences arose between him and other members, he was forced to resign.
He then went to the boards of directors of the funds administered by the management company, and by convincing them of the merits of a mutual mutual fund company, they gradually chose to move under the Vanguard umbrella. Since then, Vanguard has internalized the management functions, lowered costs, and become the largest mutual fund company in the world.
Why Invest with Vanguard?
#1 Mutual Ownership
As the only mutually-owned mutual fund company in the world, Vanguard has eliminated many of the conflicts of interest inherent in the structure of other mutual fund companies.
At some companies, such as Fidelity, the fund management company is owned by private owners (the Ned Johnson family). The fund management company then administers the mutual funds, which are owned by the shareholders (you and me.) Obviously, the owners of the fund management company want to make some money. Guess where that profit comes from? Yup, you and me.
At other companies, such as Charles Schwab or T. Rowe Price, the fund management company is owned by public investors, and its shares are traded on the stock market. Those investors also want to earn dividends and want their share values to go up. Guess where the money to do that comes from? You're right again — from the owners of the mutual fund shares, you and me. So there is a significant conflict inherent in the structures of most mutual fund companies.
At Vanguard, the management company is owned by the mutual funds, which in turn, are owned by you and me. There are no profits or dividends that need to go to the mutual fund company's owners. What does that mean? It means we get to keep them and it increases our returns over time.
#2 Low-Cost Leader
The means by which Vanguard sends these profits on to you is by lower expenses. In 1990, the average Vanguard expense ratio was 0.35%. The average of the rest of the industry was 1.09%, an advantage of 0.74% a year. Between 1990 and 2011, things got even worse (? better.) In 2011, when I first wrote this post, Vanguard's average expense ratio was 0.25% and the industry had increased to 1.38%, a difference of 1.13% a year.
You don't need to know much about compound interest to know that 1.13% a year compounded over 2 or 3 decades is a huge amount of money. Fortunately, in 2020 Vanguard's average expense ratio is 0.10%, just 40% of what it was when I wrote this post. The rest of the industry has realized that we, the investors, have caught on, and the average industry expense ratio is now down to just 0.58%.
#3 Vanguard Funds Outperform Peers
As you would expect, these lower expenses allow Vanguard funds to outperform their peers, especially in the fixed income categories. Time after time, over any reasonable time frame, Vanguard funds outperform the majority of their peers. Over the last ten years, Vanguard funds outperformed 85% of their peers.
#4 Index Funds
Although there was an indexed account for institutional investors at Wells Fargo in 1971, the first real index fund, the First Index Investment Trust was founded by Jack Bogle in 1976. Known today as the Vanguard S&P 500 Index Fund, it is still the largest index fund in the world, with over $543 Billion in assets, more than the GDP of Argentina, and 5 times the size of the fund in 2011 when I originally wrote the post. (If you care, there are no real actively managed mutual funds in the top 20 anymore.)
Since then Vanguard has established dozens of other index funds. A good index fund not only uses ultra-low costs to its advantage, but it also eliminates manager risk. It is well-known that most mutual fund managers don't add value once the cost of the management is added in. Index funds essentially trade the possibility of outperformance for the guaranteed elimination of market underperformance. 85% of our retirement portfolio and 100% of our children's portfolios are invested in index funds.
Other Reasonable Brokerage Choices
These days, you can get low-cost index funds at any brokerage firm (eTrade, etc) by buying Vanguard, iShares or Schwab ETFs. If you still prefer traditional mutual funds, you can also get good, low-cost, broadly diversified index mutual funds at Fidelity or Charles Schwab. But Vanguard is still usually my default recommendation because it offers more index funds and it doesn't treat them like a loss leader to sell other funds or services.
Problems with Vanguard
Is Vanguard perfect? Not even close. They have certainly had some growing pains managing their rapid growth over the years.
Their focus on low costs has predictably led to complaints about their web interface, although having used TD Ameritrade, Vanguard, Schwab, and Fidelity I find it fine for my purposes.
There are also some other quirks you may notice at Vanguard, such as the fact that their individual 401(k) doesn't accept IRA rollovers, a frequent need for white coat investors trying to do Backdoor Roth IRAs.
So when choosing a mutual fund company to open an account with, Vanguard should be your default option. Instead of taking the profits for himself, St. Jack (Bogle) opted to change the mutual fund industry forever and allow the investors to keep the change. Over your investing career, this will probably be hundreds of thousands of dollars you get to keep in your pocket. Now if I could just get them to sponsor this blog…
What do you think? Where do you invest? What mutual funds or ETFs do you use? Comment below!