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Vanguard's fees are costing me a new car?

Vanguard's fees are costing me a new car?


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This article was posted July 1, 2013.

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Invest with DFA Funds, 12-Step Program

I recently noticed that the Federal Government Employees Thrift Savings Plan (TSP) has an annual expense ratio of 2.7 basis points. That's a small fraction of Vanguard's average of 18 basis points for their funds. Even the simple portfolio below of three low-cost Admiral funds comes in at 10 basis points (i.e., expense ratio of 0.10%). A topflight corporate 401(k) plan like ExxonMobil's would have an expense ratio of 3.5 basis points for the same asset allocation.



$1 Million Retiree Portfolio Using Three Low-cost Index Funds
Allocation
($)
Ticker
Symbol
Fund Name Expense
Ratio
(%)
Annual
Fee
($)
Portfolio
Turnover
(%)
Brokerage
Comm.
(%)
Bid/Asked
Spread
(%)
Implicit
Costs
(%)
Total
Hidden
Costs
(%)
Total
Costs
(%)
Total
Costs
($)
$400,000 VFSUX Vanguard Short-Term Bond Admiral Shares 0.10% $400 48% 0% 0.00% 0.00% 0.00% 0.00% $400
$300,000 VTSAX Vanguard Total Stock Market Admiral Shares 0.05% $150 4.5% 0.003% 0.42% 0.019% 0.022% 0.072% $216
$300,000 VFWAX Vanguard FTSE All-World ex-US Index Admiral 0.15% $450 5.6% 0.012% 0.45% 0.025% 0.037% 0.258% $561
------- . ------- ------- ------- ------- ------- ------- ------- ------- -------
$1,000,000 = Total Portfolio Total Portfolio Expense = 0.10% $1000 N/A N/A N/A N/A N/A 0.1177% $1177


That 7.3 basis point difference really adds up over a person's lifetime. To illustrate this, the Retire Early Home Page Fee & Commission Shaft Detector was used to calculate how much of an investor's wealth is captured by the mutual fund manager and/or financial advisor over time. For example, the spreadsheet below shows the results for a client investing in funds with an expense ratio of 2.00% per year (about what Wall street expects to skim from a client.) The benchmark is the 2.7 basis point annual fee for the Federal Employees' TSP. The Shaft Detector assumes that the higher cost mutual fund manager invests the excess fees they take from the client in the benchmark portfolio and calculates the value of their portfolio over time (see the red bubble on the spreadsheet below.) You can change the figures in blue on the spreadsheet to run your own numbers.







If we look at a 60-year time frame (i.e., 30 years saving for retirement, 30 years spending money in retirement) you get the results in the table below.

The difference between TSP and Vanguard at the end of 60 years is enough to buy a mid-sized car (i.e., $33,804). For someone paying the usual 2% fees and expenses that a Wall Street firm expects to extract from a client, the $613,319 difference is about enough to buy three median-priced homes (e.g., median US existing home sales price as of May 2013 is $208,000)

Some small company 401k plans managed by insurance companies have fees as high as 4.8% per annum. As the table below shows, at that fee level you'd almost do as well taking your monthly retirement contribution in cash -- and then setting it ablaze on your veranda.



Comparison of Portfolio Value for Varying Investment Fees over a 60-year Time Frame
$125,000 initial balance, $5,000/yr annual contribution, 4% inflation-adjusted
withdrawal starting in year 31, 6% per annum investment return, 3% inflation
====== Figures in constant dollars ======
Fund Name Expense Ratio
(%)
Starting
Account Balance
($)
Balance in
Year 30
($)
Annual Withdrawal
in Year 31
($)
Balance in
Year 60
($)
Wealth Captured
by Fund Manager
in Excess Fees
($)
Federal Employee TSP 0.027% $125,000 $465,106 $18,604 $320,797 N/A
Vanguard Admiral Fund Portfolio 0.100% $125,000 $456,304 $18,252 $307,904 $33,804
Wall Street Firm -- Target Fee 2.000% $125,000 $278,980 $11,159 $105,816 $613,319
Small Company 401(k) - Worst Case 4.800% $125,000 $138,976 $5,559 $22,092 $927,863


Note (1) Starting balance of $125,000 was chosen so that the 40% allocation to the Vanguard Short-Term Bond Fund would meet the $50,000 Admiral minimum.




What's the biggest difference between Vanguard and the Federal Gov't Employee's Thrift Savings Plan?

The Investment Company Institute (the lobbying arm of the mutual fund industry) lists several aspects of the Thrift Saving Plan that allows it to operate with lower costs. The first is the economies of scale it enjoys due to its tremendous size (seven times the size of the largest corporate 401(k) plan, IBM's.) The TSP also gets some free bookkeeping and enrollment help from the Federal agencies covered by the plan. And ICI complains that the Federal Employees’ Retirement System Act of 1986 (FERSA) regulations are less onerous than the ERISA law that private 401(k)s must follow.

But, by far the most startling difference is the large gap in executive compensation between Vanguard (and other Wall Street firms) and the TSP.

TSP Executive Director Gregory Long (who has done a spectacular job in keeping costs down for his investors} earns $165,000/year as one of the top 200 bureaucrats in the Government. The five member Board, all business & investing heavyweights appointed by the President, earn a bit more than $600/day when conducting Board business (typically one or two days a month.) This goverance model has to be one of the great bargains in the investment world.

Vanguard operates with a big money model closer to what you'd expect to see on Wall Street. The ten "independent" directors on Vanguard's Board average about $215,000/year in compensation for a part-time job. Vanguard doesn't disclose executive pay to its owners (i.e., Vanguard's customers), but Investment Week put Vanguard CEO compensation at $6 million to $10 million in 2007. I suspect run-of-the-mill management entitlement has boosted that to the $10 million to $15 million range for 2013.

Of course the predations of Wall Street leaders are well known (and disclosed.) For 2012, Morgan Stanley CEO Jamie Dimond made $11.5 million after being docked for trading losses, Goldman Sacks CEO Lloyd Blankfein made $13.3 million, and of course the Johnson family that runs Fidelity Investments collected enough in fees and commissions over the years to become billionaires many times over.

In terms of assets under management, Vanguard has about $2 trillion, TSP about $335 billion, so Vanguard is 6 times the size. Does it make sense to pay Vanguard's top dogs 60 or 80 times the compensation of TSP's leaders? I guess it's a moot point since Vanguard's "owners" don't get a vote or even proper disclosure.

I'll say one thing though. Give me the opportunity to invest in a Gov't-run program like the TSP, and I'd drop Vanguard like a hot stone.



Resources for more information

ExxonMobil Savings Plan Brochure (PDF) -- Fund expense ratios and 401k mgmt fee on page 17 of document. Annual fees ranges from 2 basis points for the bond fund to 6 basis points for the international equity fund.

USA Today -- Are fees draining your 401(k) retirement savings? (Aug 25, 2009) Article notes that some small company 401(k) plans can have annual fees & expenses as high as 4.8% of assets.

Forbes -- Hidden Treasures (Oct 28, 2002) Article on Vanguard Group CEO compensation and lack of disclosure.

Investment News -- Vanguard bonus increase may hit 11-year high (Jun 11, 2007) Article on Vanguard Group Partnership Plan puts CEO compensation in the $6 million to $10 million range.

Investor Place -- Vanguard Partnership Plan Pays Despite Performance (Jun 25, 2012) Article on Vanguard Group Partnership Plan.

The Federal Thrift Savings Plan: A Model for the Private Sector? (2008) Lobbying arm of the mutual fund industry complains that it's not fair to compare their products to the low costs of the TSP.

Compensation of Executive Director, Federal Retirement Thrift Investment Board, Gregory Long -- Mr. Long is a Level III on the Executive Schedule earning $165,000 per year.

Compensation of the Federal Retirement Thrift Investment Board -- Board members are paid the daily rate for a GS-18 (i.e., Level III on the Executive Schedule) while performing board business (about $600/day).


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Copyright © 2013 John P. Greaney, All rights reserved.

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