Low-Cost Investing: Is There a New Sheriff in Town?

Vanguard has reigned supreme as THE low-cost investment company. Fidelity is catching up. Is there someone else to look out for?When I started my financial journey just a few years ago, Vanguard was THE company when it came to low-cost investments.  With John Bogle as its founder, what else would you expect?  It wasn’t until the middle of last year that Fidelity jumped onto the low-fee bandwagon.  And now, given more recent events, there looks to be a new leader in low-cost index funds.

 

Low Fees but High Buy-In

First, let me give you a little bit of context.  I heard about Vanguard during the last year of my residency (2014).  I had learned about investing through index funds and was eager to put this knowledge to good use.  Unfortunately with Vanguard you have to pay to play.  The $3,000 minimum was too steep for my resident salary.  Even if I saved an extra $300 a month, which was tough to do in an expensive city such as Chicago, it would have taken me ten months before I would have the required funds.  Once I graduated, though, I was quick to open my account and start my adventures in index fund investing.

 

A New Low-Cost Player in Town

I’ve pretty much been a Vanguard fanboy since then.  And with good reason.  Their offerings jive with my investment style; I prefer passive, low-cost index funds and ETFs.  And it looks like the “fad” of passive investing is catching on.  According to a Morningstar report, actively managed U.S. equity funds saw an outflow of $263.8 billion while passively managed funds took in $236.7 billion last year.  Who got most of the action?  Vanguard, of course.  They took in almost $257 billion of passive investments.

Vanguard dominates the low-cost passive investment shift.

But it seems as if the low-fee investment landscape is changing.  In July of last year, Fidelity lowered the expenses of 27 index funds and ETFs, a move that put them pretty much in line with Vanguard’s equivalent offerings.

Hold up, wait a minute.  I wasn’t alluding to Fidelity as the new low-cost sheriff in town.  Charles Schwab, a company not even listed on Morningstar’s table, dropped a bombshell.  On March 1, expenses for their market cap index funds (i.e. Total Stock Market Index Fund) were lowered to align with their ETF counterparts.  How will this change affect investors?  Well, let’s consider someone who is assembling a three-fund portfolio using total stock market, total international, and total bond index funds.  Here is a side by side comparison between the three companies.

* Vanguard and Fidelity Investor Class Funds

 

Wow… an expense ratio of 0.03% on a total stock market index fund?  And with an initial investment amount of $1?  Sign me up!  The difference between fees narrows when you compare Schwab’s funds to Vanguard’s Admiral Shares and Fidelity’s Premium Class.  But keep in mind that the initial investment amount is a hefty $10k.

* Vanguard Admiral Shares and Fidelity Premium Class

 

What Does This Mean?

So, does this mean that you should move all of your investments over to Schwab?  Well, no… don’t be ridiculous.  After all, we’re talking only a few basis points of difference here.  Once the expense ratios get this low, there really is a law of diminishing returns going on.  I mean, how much of a difference does an expense ratio of 0.16% versus 0.03% make?  Well, if someone were to invest $18k a year for 30 years with a 7% annual rate of return, the difference between the two would be about $40,000:  $1.63 million for the 0.16% fund versus $1.67 million for the 0.03% fund).  Using a 0.05% expense ratio, such as with Vanguard’s Total Stock Admiral Shares, drops that down to just $6,000.  Are these differences significant enough for you to spend all that time and energy switching over to Schwab?  Probably not.

Another thing to keep in mind is that Schwab’s new fees only apply a few index funds.  While their new low-cost index funds should be enough to create a diversified portfolio for most investors, others may find the options a bit limiting.  For instance, you would have to look elsewhere if you wanted to tilt your portfolio toward small cap value or international emerging markets.

 

In Conclusion

I think Schwab’s changes would be the greatest value to someone who is just starting out with investing.  Not only are the extremely low expense ratios amazing, but the initial minimum investment is unreal.  I think this is going to attract a lot of new investors and pull some of them away from Vanguard and Fidelity.  As I said at the start of the article, the $3k minimum investment with Vanguard was a major hurdle for me given my income and ability to save money.  Had Schwab’s low-cost index funds been available at that time, I might have turned out to be a fanboy of Mr. Schwab instead of Mr. Bogle.  In the end, I think the customers benefit the most from this type of competition.  Who knows, maybe other investment companies will throw their hats into the ring and lower their fees to follow suit.

 

Readers, what do you think about the price wars between Vanguard, Fidelity, and now Schwab?  Share your thoughts and comments below!

 

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30 comments

  • It’s really great to see all of these low cost options out there these days. Competition is good. I think anyone really can’t go wrong going with any of these type of funds.

  • This is neat! Competition is the lifeblood of capitalism, after all, so it’s good to see someone challenging Vanguard.

    • If only there was more competition for cable and internet service providers in my area. Haha! I think it will be interesting to see how things go moving forward.

  • I agree…bring on the competition! Should keep Vanguard honest, and maybe they’ll even find ways to become even more cost efficient. Either way they win, since the big guys have clearly capitulated, and are following in their footsteps.

  • Wow, I haven’t looked at Charles Schwab in years. All of our 401(k) money is in Fidelity and we have a modest brokerage account there too. Our IRAs and another brokerage account are with Vanguard. Like you mention, it’s not worth moving for a few hundredths of a percent, but it’s good to know that Schwab is taking the passive index area seriously.

    • To be honest, if my wife and I didn’t have an old brokerage account with Schwab I probably wouldn’t have known about these changes. Probably not too much of a game changer for those with established accounts, but definitely one for new investors.

  • Interesting. I knew about Fidelity but didn’t know Schwab had joined the party. Competition is good. Vanguard has owned low cost investing forever. It will be interesting to see how much this changes things if any.

    • Yes competition is good. I think this will affect new investors more than those with accounts already established with these three companies.

  • This competition is incredible. I remember when fees were not something that people talk about. Heck, Dave Ramsey advises people to ignore fees. Which I think most people would agree is the wrong thing at this point.

    I’m definitely looking forward to the day when they pay us to hold the funds 🙂 That will be the day!!!

    • Paying us to hold funds… that would be amazing! Who knows, though, maybe there will be a day when zero expense ratio funds become an option! Thanks for stopping by!

  • I think back to my first investment and my broker taking 60 dollars a trade. How things have come along that you can no buy a basket of thousands of stocks for loose change.

    • Ouch. $60 buck per trade? That’s crazy. Things have definitely come a long way for the individual investor. Thanks for stopping by, FTF!

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  • I personally just stick to exchange trade funds (ETF). Almost no management fees, and these ETF’s track their underlying markets exceptionally well. Before the time of ETF’s, it would have been very hard to invest in whole indices (e.g. the S&P 500).

    • Thanks for stopping by, Troy! ETFs are a great option. I tend to favor index funds, but they are both pretty similar. I personally don’t do a lot of intra-day trading and don’t want to think about the bid-ask spread, but otherwise they are both great low-cost options.

  • There’s not much I can do with my taxable account, but I might take a serious look at my non-Vanguard options for the sizable Roth IRA I’ve got if the cost discrepancy persists.

    .02 difference isn’t much, but on a million dollars, it’s a couple hundred bucks a year. [I hope I did the math right 😉 ]

    Cheers!
    -PoF

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  • If you consider ETFs, there are (at least) two more conisiderations and competitors for Schwab with low minimums and no cost to trade if you pick the correct platform:
    1. ishares ETFs
    2. Vanguard ETFs
    (And, of course, Schwab ETFs)

    Two other points:
    1. Your non-Admiral class Vanguard index funds will convert to Admirl automatically at $10,000
    2. Vanguard still has the largest number of low cost index funds (considering all of the style box permutations) and low cost actively managed funds.

    • Thanks for stopping by, VagabondMD. I agree that there are a lot of low-cost ETFs out there, and that basically it’s about finding a platform that doesn’t charge commissions on trades. You’re also still limited by the market price of the ETF. After all, $1 is still cheaper than the $120 for Vanguard’s Total Market ETF.

      Yes the non-Admiral funds eventually convert to Admiral Shares, although it doesn’t change the fact that you need to put in $10k to get there. Vanguard does have a lot of low cost index funds, and it’s the primary reason why I’m such a big fan. You have a lot more options when it comes to constructing more complex portfolios. However for an investor who is fine with sticking to a 3-fund or 4-fund portfolio, Schwab’s offerings are definitely intriguing.

      Thanks for visiting!

  • I love what competition has done since I started investing! It’s also noteworthy that Schwab’s OneSource ETFs are free of any commissions whatsoever. Commissions aren’t as much of a drag on large accounts, but it helps a lot when you’re investing that $1 minimum!

    • Yes competition is great for consumers and investors! It’s definitely great that investors who are just starting out have several low-cost options to consider. Thanks for visiting!

  • This only accounts for the stated fees of the fund. What about trading costs and tracking error?

  • One thing you have to be careful of is that the fees aren’t everything. You need to look at whether the returns of these indicies are the same. Some will advertise lower fees but make it up by lending out the shares to shortsellers and then pocketing that instead of giving it to investors as they should.

    competition is good but as consumers we have to make sure we are informed and not just looking at headline numbers.

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  • Love the competition, it’s a welcomed sight. I’d primarily be interested in adding them to the aresenal when tax loss harvesting and keeping the money invested in a comparable investment.

    Great post!

  • Nice article! I actually noticed as well that Fidelity had started to get competitive with fees compared to Vanguard. Had no idea about Scwab though! Fortunately, I’m able to invest in VSMPX through my employer, which has a 0.02% fee!

    Feel free to swing by my site if you’re so inclined! From one medical professional to another (I’m an RN) 🙂 – DoggedFI.com. Cheers!

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