(PUB) Investing 2016

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14 • Fund Family Shareholder Association
VANGUARD HAS GROWN into the
largest mutual fund company by put-
ting shareholder interests ahead of their
own. They tend to do this better than
any other mutual fund company.
And Vanguard’s focus on lower-
ing cost has saved investors millions
and millions of dollars over the years.
But Vanguard is not perfect—far from
it. In many areas, Vanguard could
stand to improve their services and be
more transparent. In some instances,
Vanguard could step up and take more
of a leadership position within the
industry beyond simply charging less.
By shining a light on these places, I
don’t intend to dissuade you from buying
and holding Vanguard funds—Dan and I
both own Vanguard funds personally.
We are not about to abandon offering
our independent take on the good, the
bad and the ugly at Vanguard. While we
will both continue to applaud Vanguard
when they are doing something right,
Vanguard has plenty of cheerleaders in
the media, and I’d be doing all of us a
disservice if I didn’t call out Vanguard
when they could be doing better.
Vanguard isn’t being devious or
nefarious by not telling you these 10
“secrets.” In fact, these aren’t truly
secrets—you just have to know where
to look and be willing to turn a skepti-
cal eye on Vanguard’s pronouncements.
Let’s start with four this month, and
cover the remaining six next month.
1. Investors are paying Vanguard half
a billion dollars to run its largest stock
index funds—and those costs have
been rising in dollar terms even as
expense ratios have fallen in percent-
age terms.
How did this happen? Well, at the end
of 1993, with $11.9 billion invested in
500 Index, Institutional Index (which is
the institutional version of 500 Index) and
Total Stock Market combined, the aver-
age expense ratio paid by shareholders
was 0.14%. That generated $16.8 million
in fees to run the two index funds.
Fast forward to the end of 2015, and
investors held $853.9 billion across
the different share classes and clones
of 500 Index and Total Stock Market
Index, and paid an average expense
ratio of 0.06%. So yes, the expense
ratio dropped significantly—0.14% to
0.06%. But the dollar cost to run 500
Index and Total Stock Market Index has
soared to over $500 million.
So does that mean what Vanguard
was able to do for under $20 million
in 1993 now costs it half a billion dol-
lars? That’s an average annual increase
of 17%, well ahead of the 2% annual
rate of inflation we’ve experienced.
Had costs increased at the pace of
inflation, it would only cost Vanguard
$27 million or so to run the two index
funds today—which translates into an
expense ratio of 0.003%.
It is hard to fathom how it costs
$500 million to run just two index
funds. Though the new Institutional
Plus shares of 500 Index and Total
Stock Market charge just 1 basis point
(which sounds like Vanguard is giv-
ing their services away for free), on a
minimum investment of $5 billion, that
translates into $500,000.
I realize that Vanguard has many,
many more annual reports and account
statements to print and mail because
these index funds have many, many
more shareholders to service. To
Vanguard’s credit, in recent years, fee
revenue has not grown as quickly as
the two funds’ skyrocketing asset lev-
els. Still, at the very least, it begs the
questions: What does Vanguard really
mean when it says it runs funds at cost?
How is that cost determined? Are some
of those fees being used to subsidize
expenses elsewhere within Vanguard?
While I applaud the trend of lower
expense ratios, Vanguard’s size and
the billions it takes in every year raises
the question of whether costs could be
lowered even further.
2. Vanguard is a non-profit with a
profit-sharing plan. And being a
Vanguard partner has been much
more lucrative than being a Vanguard
fund shareholder.
The Partnership Plan, created
in 1984 by founder Jack Bogle, is
VANGUARD
10 Things Vanguard Won’t Tell You (Part 1)
Expense Ratios Have Come
Down, But Fee Revenue Is Up
Fee Revenue
Expense Ratio
12/9412/9712/0012/0312/0612/0912/1212/15
Fee Revuene ($ millions)
Asset-Weighted Expense Ratio
$0
$100
$200
$300
$400
$500
$600
0.00%
0.02%
0.04%
0.06%
0.08%
0.10%
0.12%
0.14%
0.16%
0.18%
Fee Revenue Hasn’t Kept
Pace With Asset Growth
Fee Revenue (LHS)
Combined AUM (RHS)
12/9412/9712/0010/0312/0612/0912/1212/15
Fee Revuene ($ millions)
Combined Assests ($ millions)
$0
$100
$200
$300
$400
$500
$600
$0
$100,000
$200,000
$300,000
$400,000
$500,000
$600,000
$700,000
$800,000
$900,000
Partnership Distributions
Have Outpaced 500 Index
Partnership Dividend
500 Index Fund
19841987199019931996199920022005200820112014
$0
$20
$40
$60
$80
$100
$120
$140
$160
$180