Written by Jimmy Becker

Vanguard and the Buffet Bet

Vanguard is the largest firm in the mutual fund industry. They manage $5 trillion (yes, with a “t”) of investor assets and are roughly the same size as the number 2, 3, and 4 firms combined.

You may be wondering:

1.  Why have they been so successful?

It’s simple — their fees are significantly lower than everyone else. As I have noted, fees have a meaningful impact on your long-term savings growth.

2.  Why are their fees so much lower?

Vanguard has a unique ownership structure. It is essentially organized as a non-profit in which the mutual fund investors (that’s you and me) own the investment management company and the operating expenses are passed on to the mutual funds at their actual cost. Instead of profits accruing to owners, they are converted into lower expenses.

Also, Vanguard mostly offers passively managed index funds. These funds are less expensive to operate than actively managed funds for which portfolio managers are doing costly financial research.

3.  With these lower fees, do you get what you pay for?

Investment expenses are a zero-sum game — the mutual fund profits come directly out of your pocket. Fees are a dead-weight loss to your net returns.

If you think higher fees do produce higher net returns, then I refer you to Warren Buffet’s now-famous bet from ten years ago. In Buffet’s own words:

“I argued that active investment management by professionals — in aggregate — would over a period of years underperform the returns achieved by rank amateurs who simply sat still. I explained that the massive fees levied by a variety of “helpers” would leave their clients — again in aggregate — worse off than if the amateurs simply invested in an unmanaged low-cost index fund…

I publicly offered to wager $500,000 that no investment pro could select a set of at least five hedge funds — wildly-popular and high-fee investing vehicles — that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees. I suggested a ten-year bet and named a low-cost Vanguard S&P fund as my contender. I then sat back and waited expectantly for a parade of fund managers — who could include their own fund as one of the five — to come forth and defend their occupation. After all, these managers urged others to bet billions on their abilities. Why should they fear putting a little of their own money on the line?

What followed was the sound of silence…”

Only one person was brave — or foolish — enough to take the bet and he selected five hedge funds to compete against Buffet’s index fund.

Buffet announced the ten-year results earlier this year and it was a rout. The Vanguard index fund had an average annual return of 8.5%. The best performing hedge fund could only achieve an average annual return of 6.5% and the worst of the five had an average annual return of 0.3%. I have no rational explanation for why any investor would opt for those high-cost, but low-performing funds.

John Bogle, the Vanguard founder, has explained it best, When it comes to investing, you get what you don’t pay for.”

4.  Is my enthusiasm for Vanguard influenced by some consideration I receive from them?

It’s a good question. As my clients and workshop students know, I recommend Vanguard to everyone I work with. But, no, I don’t receive any benefit for making the recommendations.

You cannot choose where to invest your 401K funds because you are limited to your employer’s plan administrator and their choice of mutual funds. However, when you have an IRA or other savings, use Vanguard. You’ll be in lots of company and ultimately, wealthier for doing so.

Have questions? get in touch.

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Update: On August 1, 2018, Fidelity responded. They now offer two index funds with zero fees and another 20 that, as of now, have lower fees than the equivalent Vanguard funds. You can compare the fees here.