Who Is Winning the Fee Wars? April 7, 2017 Adviser Fund Update Print Fee Wars Now About Bragging Rights? In February, we covered Charles Schwab & Co.’s latest shot across Vanguard’s and Fidelity’s bows when it announced it was reducing index mutual fund fees to align them with its ETFA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index. equivalents, while also eliminating investment minimums for those passive investment vehicles. A week ago, a full-page ad in The Wall Street Journal from Schwab caught our eye and got us thinking about index funds and fees. Claiming “decades of advantages,” the advertisement compared the Schwab 1000 index to the S&P 500 index and, not surprisingly, declared Schwab’s product the winner. A couple of things to point out here. To start, Schwab’s ad was about attracting investment dollars to its funds. Thus, it’s important to understand that the Schwab 1000 index is not the same thing as the Schwab 1000 Index fund (the latter is investable and charges fees, the former is not and its returns are not reduced by expenses), nor is it the best comparison to the S&P 500 index. Schwab’s 1000 index includes twice as many holdings, and it has more exposure to mid-cap stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. than the S&P 500. The Schwab 1000 Index fund was one of the beneficiaries of Schwab’s fee reduction earlier this year, and from a cost perspective, it is now much more competitive with similar offerings from Fidelity and Vanguard. All three of the firms have taken turns touting lower fees than each other and the rest of their competitors on their index funds and ETFsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index. of late, but sometimes the difference is as small as a half of a basis point, or 0.005%, on a fund already charging single- or low-double-digit operating expenses. To focus on a basis point or two is pretty ridiculous at these already low levels. Why? Let’s put it in real dollar terms. One basis point on a $10,000 investment is a measly $1. At $100,000, that’s just $10, which, depending on where you live, is little more (or less) than the cost of a lunch out these days. To take it a step further, halving a 0.10% expense ratio down to 0.05% is a 50% reduction (percentage terms is typically how fund firms frame the changes when they market them), but it only represents a $50 difference on a $100,000 investment, which hardly moves the needle. If that same investor was in a fund that made a 50% reduction on a 1.00% expense ratio, they would save $500 a year in fees—something worth getting excited about. At the current rock-bottom index fund expense levels, even Vanguard has fessed up that this is all about marketing and bragging rights, which might just be an admission that’s there’s really not much lower to go (though our regular readers will surely recognize that the fund giant has been the biggest promoter of its own incrementally lower expense ratios). Which Index Is Best? To get back to the claim that its index is better, we’ve put Schwab’s 1000 index and the fund tracking it side-by-side with a number of other low-cost portfolios from Fidelity and Vanguard. A couple of things are apparent in the table. First, all of these funds tracked fairly closely to one another over all of the time periods, somewhat weakening the argument that one broad U.S. stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. market index can claim to truly be superior to any other in a meaningful way (especially using point-in-time returns, as we’ve done here for simplicity’s sake). Second, you can very clearly see the impact of expenses on the Schwab 1000 Index fund’s return when compared to its benchmark. It may charge 0.05% in fees today, but before February 2017, its expense ratio was 0.29%, and the bite those relatively higher expenses took over time is clear. Finally, Schwab’s diversificationA strategy for managing investment risk by investing in a mixture of different investments. Since different asset classes face different risks, even if one type of asset declines in value, others may not. argument works against the 1000 index fund if you expand the comparison to include total U.S. stock market indexes. Both Fidelity’s and Vanguard’s options, regardless of share class, outperformed the Schwab 1000 Index fund over all of the different time periods. The underlying index was more competitive, but investors couldn’t get those returns, because you can’t invest in an index. We’re all for people being able to keep as much of their hard-earned money as possible, and the fee wars have driven prices down for countless investors of every stripe. Just remember, while firms are racing to the bottom to lower fees, in the end, it all comes down the performance of your portfolio. Low fees are a great quality in a fund or investment, and can contribute to better returns over higher-fee competitors over time. That said, the return after expenses of the underlying investment has a far greater impact on investors’ experience, and a low fee won’t be able to hide a lesser strategy’s flaws for long. Buyer beware! Fund/Index name Inception Expenses 5-Year Ret 10-Year Ret 15-Year Ret 20-Year Ret Schwab 1000 — — 13.15% 7.61% 7.41% 8.18% Schwab 1000 Index Fund Apr-91 0.05% 12.85% 7.34% 7.09% 7.86% Vanguard 500 Index Admiral Nov-00 0.04% 13.26% 7.50% 7.08% — Vanguard 500 Index Investor Aug-76 0.14% 13.14% 7.39% 6.97% 7.75% Fidelity 500 Index Premium Oct-05 0.05% 13.26% 7.48% — — Fidelity 500 Index Investor Feb-88 0.10% 13.21% 7.44% 7.01% 7.75% Vanguard Large Cap Index Admiral Feb-04 0.06% 13.13% 7.62% — — Vanguard Large Cap Index Investor Jan-04 0.18% 12.98% 7.48% — — Vanguard Total StockA financial instrument giving the holder a proportion of the ownership and earnings of a company. Market Index Adm. Nov-00 0.04% 13.14% 7.69% 7.65% — Vanguard Total Stock Mkt Index Inv. Apr-92 0.15% 13.00% 7.57% 7.54% 8.11% Fidelity Total Market Index Premium Oct-05 0.05% 13.10% 7.62% — — Fidelity Total Market Index Investor Nov-97 0.10% 13.05% 7.57% 7.56% — Note: Table shows annualized total returns over the periods listed through 3/31/17. Source: Morningstar. About Adviser Investments Adviser Investments is a full service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994, and have more than 3,500 clients across the country and over $6 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, with particular expertise in Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. Our minimum account size is $350,000. 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