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