I’m currently reading (and, of course, enjoying) John Bogle’s recent Enough. One question Bogle raises in the book is this: Which do you think is more important to most mutual fund companies: The return on their capital, or the return on their clients’ capital?
I like the way Dave phrased it a couple weeks back:
The purpose of the financial services industry is to make themselves rich, while making their clients “rich enough.”
Agreed. I suspect that the primary goal is to increase the profits of the fund company and that, as long as their funds are doing well enough that the clients don’t start switching to other firms, the company is happy.
So what?
At this point, the reader may ask, “Well, sure. But why is that so bad? Isn’t every company’s primary goal to make a profit for its owners?”
For the most part, yes. But I think that line of reasoning misses two important points:
1. They’re breaking the law.
The Investment Company Act of 1940 states that investment companies (such as mutual funds) must not be:
“Organized, operated, [and] managed…in the interests of directors, officers, investment advisers, depositors, or other affiliated persons…rather than in the interest of all classes of such companies’ security holders.”
In other words, fund companies are required by law to put their clients’ interests before their own. Sadly, this rule appears to be blatantly disregarded by fund companies and unenforced by regulators.
[Tangential pondering: How long would a doctor keep his license to practice if it could be conclusively shown that more than 50% of his clients would have been better off having never utilized his services? For 30+ years, we've allowed various fund companies--and, for that matter, the entire actively-managed fund industry--to operate, despite the fact that we can conclusively show that more than half of their clients would have been better off without them.]
2. Why not avoid the whole mess?
More to the point for the individual investor, though, is this: Why would you choose to invest via a company that puts your interests second when there is a company that truly does put its clients first?
In case you don’t know what I’m talking about: Vanguard has a unique ownership structure such that the company is actually owned by the people who invest in their funds. (That is, the clients are also the owners.) As a result, the conflict of interests described above is eliminated entirely.
In other words…
- Unlike every other fund company, Vanguard is owned by its clients.
- Vanguard has consistently been the lowest cost fund provider throughout the last three decades.
- Vanguard’s funds repeatedly dominate the competition in their respective asset classes.
I suspect that those three facts are somehow related. 
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{ 21 comments… read them below or add one }
I had no idea about the investment act! Learned something new already today
I like Vanguard, too. Good products low costs.
You make a compelling argument Mike. For most investors, your logic is indisputable.
Those are exactly the reasons I use Vanguard exclusively. Great points!
There is a difference between investment companies, e.g. mutual funds, and management companies, e.g. Fidelity, Vanguard, etc. Nobody ever expected the management companies to do anything but maximize profit.
And folks went to doctors for centuries before they did any good.
Frank: Thanks for bringing that up. It appears I oversimplified.
The issue, really, is that the directorship of the investment company (the fund) tends to have a very large overlap with directorship of the management company, thereby leading the fund directorship to use the management company with whom they’re affiliated, despite the fact that it is likely not in the fund investors’ best interests.
As to doctors: Yeah, I’ve heard that prior to the invention of penicillin, the medical profession killed more people than it saved. But would we still stand for it (especially if we literally knew for certain that the doctor was doing more harm than good)?
I had no idea that Vanguard is owned by its clients. I like that business model! What’s more, Vanguard has now entered the UK market. Their UK index tracker has an AMC of 0.15% – previously unheard of this side of the Atlantic! (See: https://www.vanguard.co.uk/products/fees.html )
When I get in the situation where I can start investing I think Vanguard will now be my first port of call. Fortunately they have found at least one funds supermarket to sell their funds for them (a challenge because they apparently refuse to pay rebates).
P.S. For American readers: the 0.5% purchase fee is the stamp duty tax imposed by the government.
Niklas: Very cool.
A question for you, as I’m, well, oblivious about investing for people outside of the U.S.: Are Vanguard’s ETFs available to you via regular online discount brokerages? (And would they be subject to the stamp duty tax?)
Woh Mike, I did not know that about Vanguard’s ownership structure. That is very interesting, and certainly makes me want to learn more about their financial products – thanks for the heads up!
Mike: I think the EFTs are available, though perhaps only on US exchanges (thus probably a bit more expensive to buy than UK EFFs like iShares). But they won’t be subject to stamp duty as they are not domiciled in the UK. In fact, iShares avoid stamp duty by being domiciled in Ireland, though they are traded in London (as far as I know).
Interesting. I didn’t know that about Vanguard at all. And I’ve been investing with them for years!
Niklas: Ah, I see. Regular index funds it is then. I’m happy to hear that Vanguard’s expanding its offerings into other countries. (Both because it’s good for U.K. investors and because a broader asset base should continue to lower expense ratios for current investors.)
I am at this very moment reading “4 pillars of investing” and I have been trying to finish it for a while, I actually just read the portion about Vanguard’s beginnings and how their structure helps them achieve lower costs.
At the current moment I use T. Rowe Price, in comparing the two, I know that TRP’s expense ratios are higher within the same classes, but their minimum investment is lower so it’s easier on my grad student pocket.
What I would like to know is this, what difference does it make how many mutual funds you invest in within the same company i.e. pros and cons. I’m not well-versed in ETFs and regular index funds yet, but I am still reading.
Hi Damilola. First, congrats on getting started while still in school. Also, great choice of reading. Four Pillars is without a doubt one of the very best books around. By the time you’ve finished it, you’ll know more about investing than most stockbrokers.
As to T.Rowe vs. Vanguard: When you’re just starting out with a small amount to invest each month, Vanguard might not work anyway because most of their funds have a $3,000 minimum. Also, an extra 0.2% in expenses each year isn’t all that much on a small balance.
In short, T.Rowe is a very reasonable place to start out. I’d just make it a point to switch to someplace with lower expenses once you have that option.
As to how many funds to use with each company, I’m of the opinion that 3 funds is plenty for most investors. For example, with:
1. Vanguard Total Stock Market Index Fund
2. Vanguard All World Ex-US Index Fund
3. Vanguard Total Bond Market Index Fund
…you’d be extremely well diversified. And your total costs would be quite low.
Alternatively, if you can find a target retirement fund that is both low cost and that has an asset allocation that nearly matches the one you think is ideal for your situation, you could get away with just one fund.
Hello. Vanguard funds in the uk dont have a minimum investment. You can buy them from Alliance Trust ‘platform’
I am also a student (aged 21) and want to invest in Vanguards FTSE all share tracker (just 0.15% annual fee)
Alliance Trust is the only platform at the moment to do this. The regular purchace fee is £5 does anyone think I should invest quarterly instead of monthly to stop this charge eating into my £100? and just invest £300 every quarter? i know this is a slight difference but over time i think it might add up.
thanks joe murray
Hi Joe.
Thanks for the info re: Vanguard availability in the UK.
As to your question, I personally would wait. Here’s the reasoning behind my answer:
If you invest £100 each month with a £5 fee, that’s 5% off the top. If you wait so that it’s a £5 fee per £300 investment, that’s a 1.67% commission instead. That’s a 3.33% return.
Half of the delayed money is waiting 1 month before it’s invested; half is waiting 2 months. So the average time you’re keeping the money out of the market is only 1.5 months.
In other words, you’re earning 3.33% over 1.5 months. A risk-free 3.33% return in 1.5 months is excellent.
Hello thanks for the reply Mike its really appreciated =)
I understand what you mean about the difference between the £5 creating a 5% commission on £100 monthly and the 1.67% commission on £300 for quarterly investments (the thing I was worried about is that investing quarterly might give me a less accurate ‘cost-average’ throughout the period I invest in compared to the more expensive monthly option. maybe this wont make any difference. I am not sure.
but I dont understand what you say in the second part.
“Half of the delayed money is waiting 1 month before it’s invested; half is waiting 2 months. So the average time you’re keeping the money out of the market is only 1.5 months.”
Could you clear this up?
thanks in advance
joe
Sure.
Let’s say Option #1 is to invest £100 on each of January 1st, February 1st, and March 1st.
Option #2 is to wait and invest £300 on March 1st.
What you’re gaining with Option #2 is lower costs (due to only paying commission once). What you’re giving up with Option #2 is time in the market.
The money that would have gone in on January 1st is delayed by two months. The money that would have gone in on February 1st is delayed by one month.
All I meant is that the average delay time is 1.5 months and that being in the market for those 1.5 months is unlikely to earn a return greater than 3.33%.
Though now that I think further about it, I realize that March’s investment wouldn’t have been delayed at all, making the average delay time just 1 month…. (2+1+0)÷3=1
Short version: Yes, with a £5 fee on a £100 monthly savings, I’d wait and invest every few months rather than monthly.
Ah ok I understand what you mean now. I hadn’t thought of that. Thanks for you help. I will start up my quarterly payments soonish.
Now the other dilemma….. do I need a Stocks and Shares ISA even though I am a student, will it save me money? I don’t earn anything at the moment (I study) and I am most probably working for a charity full time for at least 2 years after graduation so I think I will have to resort to going on the dole. So all in all I wont have a decent income for 3+ years. Will this lack of income made it pointless to hold an ISA?
I think I read somewhere that Capital Gains tax (which I think means tax on your profit & dividends) only kicks in if you get over £9,600 in gain. That might be completely wrong though.
I have been looking on the internet pretty consistently for a week now trying to work out wether it would be good for me to do or not but I cant seem to get any answers. I think because I want to invest in Alliance Trust’s Vanguard tracker index I might as well get the tax benefits offered by there ISA’s rather than just settle for a Share dealing account.
I am not sure if all ISA’s across the board have the same rules or are they different for each company?Should I research benefits/disadvantages of Stock and Share ISA’s in loads of different companies?
As usually I have no idea. =) any help would be appreciated.
thanks
joe murray
Well…now you’re into a range of topics I haven’t the first clue about. (I’m from the U.S. and am wholly ignorant as to tax rules in the U.K.)
Two blogs I’d suggest checking out are http://monevator.com/ and http://money-watch.co.uk/ It’s possible they’d have what you’re looking for (or be able to point you in the right direction).
Ok I will start looking right away. thanks Mike.
Joe, I’ve come to this far too late for you I suspect – apologies!
Assuming you’re only investing £100 a month, it’d be a very long time before you saw a financial benefit from an ISA. (It might even be a more expensive option – some charge a fixed annual fee).
On the other hand:
1) You save paperwork with ISAs. They are ‘tax invisible’ so you don’t have to fill in self assessment forms etc.
2) You can’t get back ISA allowances you don’t use up in any particular year. So while it might not be very useful to you now, in a few years when you’re rolling in money (let’s hope) you could wish you’d used an ISA.
I have more investments outside of ISAs then in them, and it’s pain in the neck – I wish all my money was ISA-d.
If you’re in this for the long term, use one I’d say. It’s not really any more complicated to wrap your investments in an ISA than not using one, but watch the annual fees and try to find a free option. (Make sure they’re not just taking money out of any tracker income).