Chapter 18
What is it about Vanguard anyway?
If you’ve read this far, you know I am a strong proponent of investing in Vanguard index funds. Indeed, unless you have no choice (as discussed in Chapter 17), my strong suggestion is that you deal only with Vanguard.
Understandably, such a bold recommendation is going to raise some questions. In this chapter we’ll address the four most common:
1. What makes Vanguard so special?
When Jack Bogle founded Vanguard in 1975, he did so with a structure that remains unique in the investment world. Vanguard is client-owned and it is operated at-cost.
Sounds good, but what does it actually mean?
As an investor in Vanguard funds, your interest and that of Vanguard are precisely the same. The reason is simple. The Vanguard funds—and by extension the investors in those funds—are the owners of Vanguard.
By way of contrast, every other investment company has two masters to serve: The company owners and the investors in their funds. The needs of each are not always, or even commonly, aligned.
To understand the difference, let’s look at how other investment companies (most companies, in fact) are structured. Basically, there are two options:
They can be owned privately, as in a family business. Fidelity Investments is an example.
They can be publicly traded and owned by shareholders. T. Rowe Price is an example.
In both cases the owners understandably expect a return on their investment. This return comes from the profits each company generates in operating its individual mutual funds. The profits are what’s left over after the costs of operating the funds are accounted for—things like salaries, rent, supplies and the like.
Serving the shareholders in their mutual funds is simply a means to generate this revenue to pay the bills and create the profit that pays the owners. This revenue comes from the operating fees charged to shareholders in each of their individual funds.
When you own a mutual fund through Fidelity or T. Rowe Price or any investment company other than Vanguard, you are paying for both the operational costs of your fund and for a profit that goes to the owners of your fund company.
If I am an owner of Fidelity or T. Rowe Price, I want the fees, and resulting profits, to be as high as possible. If I am a shareholder in one of their funds, I want those fees to be as low as possible. Guess what? The fees are set as high as possible.
To be clear, there is nothing inherently wrong with this model. In fact it is the way most companies operate.
When you buy an iPhone, built into the price are all the costs of designing, manufacturing, shipping and retailing that phone to you, along with a profit for the shareholders of Apple. Apple sets the iPhone price as high as possible, consistent with costs, profit expectations and the goal of selling as many as they can make. It is the same with an investment company.
In this example I chose Fidelity and T. Rowe Price not to pick on them.
Both are excellent operations with some fine mutual funds on offer. But because they must generate profit for their owners, both are at a distinct cost disadvantage to Vanguard. As are all other investment companies.
Bogle’s brilliance, for us investors, was to shift the ownership of his new company to the mutual funds it operates. Since we investors own those funds, through our ownership of shares in them, we in effect own Vanguard.
With Vanguard, any profits generated by the fees we pay would find their way back into our pockets. Since this would be a somewhat silly and roundabout process and, more importantly, since it would potentially be a taxable event, Vanguard has been structured to operate “at cost.” That is, with the goal of charging only the minimum fees needed to cover the costs of operating the funds.
What does this translate into in the real world?
Such fees are reported as “expense ratios.” The average expense ratio at Vanguard is .18%. The industry average is 1.01%. Now this might not sound like much, but over time the difference is immense and it is one of the key reasons Vanguard enjoys a performance as well as a cost advantage.
With Vanguard, you own your mutual funds—and through them— Vanguard itself. Your interests and those of Vanguard are precisely the same. This is a rare and beautiful thing, unique in the world of investing.
2. Why are you comfortable holding all your
assets with one company?
The answer is simple: It is because my assets are not invested in Vanguard.
They are invested in the Vanguard mutual funds and, through those, invested in the individual stocks and bonds those funds hold. Even if Vanguard were to implode (a vanishingly small possibility), the underlying investments would remain unaffected. They are separate from Vanguard the company. As with all investments, these carry risk, but none of that risk is directly tied to Vanguard.
Now this can start to get very complex and for the very few of you who care, there’s lots of further information you can easily Google. For our purposes here, what’s important to know is the following: You are not investing in Vanguard itself, you are investing in one or more of the mutual funds it manages.
The Vanguard mutual funds are held as separate entities. Their assets are separate from Vanguard; each carrying their own fraud insurance bonds and their own respective board of directors charged with keeping an eye on things. In a very real sense, each is a separate company operated independently but under the umbrella of Vanguard.
No one at Vanguard has access to your money and therefore no one at Vanguard can make off with it.
Vanguard is regulated by the Securities and Exchange Commission (SEC).
All of this, by the way, is also true of other mutual fund investment companies, like Fidelity and T. Rowe Price. Those offered in your 401(k) are, in all likelihood, just fine too.
If you have an employer-sponsored retirement plan, like a 401(k), that doesn’t offer Vanguard funds by all means invest in it anyway. As we’ll discuss in Chapter 19, the tax deferral and any company match contributions make these plans attractive even with subpar fund choices and high fees.
3. What if Vanguard gets nuked?
OK, let’s be clear. If the world had ended on December 21, 2012 as the Mayan Calendar suggested it might, everything you had invested in Vanguard (or elsewhere) would have gone up in smoke. But, of course, that didn’t happen.
If a giant meteor slams into Earth setting the world on fire followed by a nuclear winter, your investments are toast.
If space aliens arrive and enslave us all—unless you bought human feedlot futures—it’s gonna mess up your portfolio.
But unlikely and beyond our control, not to mention the scope of this book.
That said, lesser disasters can and do happen. Vanguard is based in Malvern, Pennsylvania. What if, God forbid, Malvern is nuked in a terrorist attack? What about a cyber attack? Hurricane? Pandemic? Power outage?
Every major company and institution is aware of these dangers and each has created a Disaster Recovery Plan. Vanguard has one of the most comprehensive going. The company is spread across multiple locations. Its data is held in multiple and redundant systems. If you care to, you can check out their complete plan at www.vanguard.com.
However, if you are expecting a planet or even just a civilization-ending event, Vanguard’s not for you. But then, no investments really are. You’re already stocking your underground shelter with canned goods. Short of that, you can sleep just fine with your assets at Vanguard. I do.
4. Am I on the take?
This book is such a strong proponent of Vanguard it is reasonable to ask: “Am I on the take?”
Nope. Vanguard doesn’t know I’m writing this and they are not an advertiser on my blog. Nor do they pay me in any fashion whatsoever.