Vanguard Funds: Proof That Smart Investors Are Getting Smarter

Alexander Green
by Alexander Green, Chief Investment Strategist Wisdom of Wealth Wisdom of Wealth

A recent article in the Wall Street Journal reports that “Many investors, rightly or wrongly, are simply fed up with stocks and are piling into bonds despite record-low interest rates.”

Let’s face it.  Savvy investors – the ones who understand how badly you can get burned in bonds when rates tick up – are not plowing their hard-earned capital into ultra-low-yielding bonds right now.  Stocks, offering higher income and far superior long-term prospects, are a much more attractive alternative right now.   Intelligent investors – the ones who are thinking rationally and not emotionally – know this.  How can we be sure?

By looking at where the smart money is flowing right now.  According to Morningstar, investors pulled a net $200 billion out of American Funds from January 2008 through June 2012.  That fund company, which has both high costs and sub-par performance, has seen 36 consecutive months of outflows.

Yet over the same period, investors pumped a net $452 billion into the Vanguard Group.  Why is this smart?  Because Vanguard has a unique structure among mutual fund companies, one that is highly favorable to investors like you and me.

Providing The Best Service at the Lowest Possible Cost

Vanguard is the nation’s largest mutual fund group with more than $1.7 trillion in assets under management.   Yet this is a not-for-profit corporation.  The funds themselves – and by extension the fund shareholders – own all of the common stock of the Vanguard Group. That means there is never any incentive to do anything other than provide the best service at the lowest possible cost.

The company’s huge asset base allows it to enjoy enormous economies of scale.  Vanguard’s costs are the lowest in the mutual fund industry.  And not by a little. The average mutual fund charges fees six times higher than Vanguard’s.  Six times!

These costs have drastic effects on performance.  Without fees, a $100,000 portfolio earning 10% a year grows to $1.08 million after 25 years.  With a 1% annual fee, the final value shrinks to $842,000.  If total fees reach 3%--as they do with some funds—the final value is only $505,000.

In short, fees matter.  Especially in a low-return environment.  If the stock market returns 5%, for instance, a 1% fee is equal to 20% of your return.

And what is true of stock funds is doubly true of fixed-income funds.  A stock manager can potentially earn high enough returns to justify his fees.  (Although few do over the long haul.)  But that’s rarely possible with bond funds – and the reason Vanguard bond funds are regularly found in the top performance quartile of fixed-income funds.

If you’ve ever wondered why The Oxford Club’s Gone Fishin’ Portfolio – a long-term asset allocation strategy that has beaten the market by a wide margin and with low risk for over a decade now – is made up entirely of low-cost Vanguard funds,  now you know.

Vanguard wasn’t built through clever advertising or ruthless business practices.  Instead, several key innovations simply make it the best choice for the majority of individual investors.  Word of mouth from happy customers – and satisfactory performance –  built this company.

In short, the interests of Vanguard and its fund shareholders are completely aligned.  That’s something you simply can’t say about any other fund company.

Good Investing,

Alex

Editor’s Note: The New York Times recently caught up with Vanguard-founder John C. (Jack) Bogle. To view the article in its entirety, click here. Bogle’s advice to investors should sound very familiar to Investment U readers...

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