Chart: Vanguard Low-Cost Philosophy At Work

The debate between active and passive investing has come full circle. We’ve officially gone from “index funds will never work!” to “index funds are working too well, it can’t keep on going”. Check out the Forbes article Is Vanguard Too Successful?

Passive vs. active is just a smokescreen. You know what really works? Low costs! There was a big hubbub when Morningstar admitted that expense ratios were a better predictor of performance than their much-advertised star ratings system. Vanguard has many successful actively-managed funds and that is due both to good managers and low costs. Wellington, Wellesley, PrimeCap, they all have expense ratios that are fractions of their competitors.

In addition, what makes Vanguard special is their inherent, longstanding commitment to low costs. Look at how the asset-weighted average expense ratio of all Vanguard funds (including actively-managed funds) has dropped since their inception:

Providers like Schwab and iShares all have some ETFs that are very low cost now, but they also have a duty to maximize shareholder value. If you’re a for-profit company and you think you can keep prices the same even as your assets rise, you do that. The very structure of Vanguard states that the investors themselves own the funds, which means they naturally pass on any savings onto the retail investor. (I do believe that the recent competition is good however and it keeps everyone, including Vanguard, on their toes.)

The “at-cost” investing structure is why the majority of my assets are invested in Vanguard funds and ETFs.

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