The average annual investment cost for an index fund far exceeds the low-cost alternative.
I’m disappointed to learn that Bill McNabb is retiring from the senior post at Vanguard after heading that company since 2008.
He and I happened to meet in Washington back in the late ’90’s when we both testified at a U.S. Department of Labor hearing. The subject matter, upon which we had both been called to speak as experts, was the destructive effect of excessive fees charged to participants in retirement plans.
While sitting together and sharing some idle chit chat, I learned that Bill had graduated from Dartmouth, not far from where I had grown up, and that his fraternity at the time had been the model for the movie “Animal House.”
Some 20 years later, having set aside his toga, there was Bill running Vanguard’s retirement services division — a major engine of his company’s growth.
Vanguard and other financial services companies should be forever grateful for the innovation of “portable pension plans” that took their expression in the form of 401(k) and 403(b) plans. The Reagan-era legislation that made these plans possible turned a nation of savers into do-it-yourself investment experts.
Compelled out of necessity to learn firsthand about the stock market, long-term employee participants have now learned valuable lessons from the school of hard knocks after having experienced seven major crashes since the early 1980s. They’ve benefited from the “magic of compound interest,” dollar-cost averaging and the “snap-back” effect that predictably follows major crashes for anyone who remains calm and doesn’t panic.
The most important ingredient contributing to success as an investor is also well-appreciated by this army of DIY investors — namely, that the only thing investors control with 100 percent certainty is the amount they pay for investment services.
Keeping these costs as low as possible is a basic investment axiom. Why? Because investment results and interest rates are totally unpredictable beyond a certain point. Once we appreciate the fact that stocks, over long periods, can be expected to rise in value and that future interest rates are unpredictable, investing is just an exercise in choosing diversified funds to do the job, keeping fees low and gripping the arms of our chairs as tightly as possible.
For Vanguard, this growing army of DIY investors was like oxygen. The mutual fund company’s ownership structure was unique at the time because it established itself as a cooperative. The only owners were the investors who purchased Vanguard funds. There are no outside stockholders benefiting at the expense of the fund’s customers.
As money poured in, the costs, as a percentage of assets, have continually been reduced. Much of that inbound money has been coming from retirement plans that have per-pay-period voluntary contributions. This explains why, in just seven years, Vanguard’s total assets have rocketed from $1 trillion to $4.4 trillion.
Today, the annual investment cost for the lowest-cost index fund is 0.04 percent — four hundredths of one percent per year, or $40 to manage $100,000. This compares to the industry-wide average charge of 1.5 percent — an annual cost of $1,500 on the same $100,000 account.
To the extent that the rest of the fund industry agonizes over pricing decisions, they are always impacted by Vanguard as the standard of comparison. The innovative company is like an Australian cattle dog nipping at so many heels in an effort to keep an industry in line. William McNabb did a commendable job at the forefront of that effort.