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Vanguard offer some of Britain’s cheapest index funds, but there’s a catch

Note on 8/8/2016: The “catch” in this article is no longer true – there is no longer a special additional charge when investing in Vanguard funds, following changes following the RDR legislation. But Vanguard is still really cheap! See our most recent list of cheap trackers.

Not many fund firms have a fanbase but Vanguard does. Its cheerleaders are the Bogleheads, disciples of Vanguard’s visionary founder John Bogle – the man who brought index investing to the masses.

Passive investors are passionate about Vanguard for two main reasons:

1. It offers index funds at rock bottom prices.
2. The company has a hard-won reputation for serving investors’ interests.

Cheap index funds are the most important weapon in the armoury of a passive investor. An influential study by Morningstar concluded:

If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision.

And since US-giant Vanguard entered the UK market in 2009, it has blazed a trail with a low cost range of index funds that rivals struggle to match.

If you’re investing for the long-term and you want a:

  • Diversified fund-of-funds portfolio – Vanguard is the cheapest.1
  • Emerging markets index fund – Vanguard is the cheapest.2
  • UK Government bonds index fund – Vanguard is the cheapest.3

The only problem is that you can’t just roll up to any online broker and start ordering Vanguard…

The Catch

Vanguard's funds are cheap, but there's a catch

Buying index funds used to be straightforward. You pick a fund from the investment platform of your choice and – if you choose wisely – you won’t get stung for dealing fees or annual administration charges.

Not so with Vanguard.

Vanguard funds are not yet freely available among UK brokers/platforms. Many initially refused to stock the funds because Vanguard wouldn’t pay them nice, cosy commissions just to play the game.

But Vanguard’s view of the world is gradually prevailing, as the UK financial industry is weened off commission by the Retail Distribution Review (RDR) shake-up.

That means Vanguard funds are turning up on more and more platforms.

Before you slap your money down though, you need to ensure two things:

  • That you choose a platform that minimises the extra charges often levied on Vanguard (and increasingly on other funds) to claw back the loss of commission.
  • That the platform stocks the Vanguard funds you want. Vanguard has the best range of index funds in the UK but many platforms only stock a limited selection.

Easy life

The simplest solution is to choose Vanguard’s LifeStrategy funds. These are fund-of-funds: a bumper pack of investments that offer a diversified, automatically rebalanced portfolio in a single wrapper.

It’s like buying a multi-pack of crisps except the Salt ‘N’ Vinegar option is flavoured FTSE All-Share, Cheese ‘N’ Onion is the rest of the Developed World, and Prawn Cocktail is the Emerging Markets.

If you follow this route then TD Direct currently offers the LifeStrategy funds without platform fees, management charges, dealing costs, or any other slippery trip hazard beyond the Total Expense Ratio / Ongoing Charge Figure, as long as your account is worth over £5,100 (ISA) or £7,500 (standard dealing account).

TD Direct also stocks a few of the other Vanguard funds – but far from all. If you want to choose from the full range then take a look at the likes of:

  1. Alliance Trust
  2. Sippdeal
  3. Bestinvest

If your broker imposes dealing charges to trade Vanguard then look for a regular investment option that squeezes fees. A one-off trade costs £12.50 at Alliance Trust, but you can slash this to £1.50 by drip-feeding in via Direct Debit using its Monthly Dealing account.

Monthly Dealing doesn’t commit you to buying the same fund month-in, month-out. You can switch funds any time you like or even stop buying after just one trade.

If you want the full Vanguard range and you make more than eight monthly purchases a year (or sell even once) then Bestinvest trumps Alliance Trust (if you hold your funds in an ISA or standard dealing account).

Sippdeal comes into play for SIPPs. You can see a more detailed comparison of the three broker’s offerings here.


Hargreaves Lansdown carries the same (limited) fund range as TD Direct but there’s no way to duck its platform charges.

You’re only better off with Hargreaves Lansdown if you can’t make TD Direct’s no-charge minimums and you only hold one fund (in your ISA) or two funds (standard dealing account) or less than six funds (SIPP).


In fact, if your strategy is to hold one or two Vanguard LifeStrategy funds in a SIPP then go with Hargreaves Lansdown.

What about rival tracker providers? HSBC come closest to matching Vanguard’s range, especially with its new C Class index funds. Like Vanguard, these funds strip out trail commission payments and have dirt cheap TERs. If you can find them unencumbered by platform fees then they can match or beat some Vanguard funds.

Again, TD Direct is the place to look, and if you want a tie-breaker to decide between the rival ranges then compare tracking error.

Some Exchange Traded Funds (ETFs) can also give Vanguard’s funds a close run for their money, none more so than its own in-house range.

ETFs are subject to dealing fees and bid-offer spreads that make their bald TERs less advantageous than they first appear. But at the very least, it’s worth comparing Vanguard’s ETFs with their index funds, where they overlap, to make sure you get the best deal.

You’ll be able to buy Vanguard ETFs at virtually all brokers who offer London Stock Exchange ETFs. You should be able to pick them up for £1.50 a throw via a regular investment scheme.

Compare your options using a fund cost comparison calculator and insert the cost of dealing fees into the initial charge section.

The Red Herrings

You may get a fright if you read somewhere that the minimum investment in a Vanguard index fund is £100,000, according to some news reports and even the official prospectuses.

But happily that’s only true if you buy direct from the firm. There’s no minimum if you invest through an intermediary like a discount broker or online platform.

The other thing that can smell a bit fishy is Vanguard’s cost structure:

  • A number of its funds charge upfront fees.
  • Received wisdom says you shouldn’t pay upfront fees on index funds.
  • Vanguard claims these fees are levied in the interests of transparency.
  • It says its rivals bundle up these fees in inflated Total Expense Ratios (TERs).

The upfront fees cover fact-of-life items like trading costs and stamp duty. Vanguard’s point is that investors are left none the wiser about these charges if they are buried in the TER.

The bottom line is that, in most cases, Vanguard’s index funds still work out to be cheaper than rival offerings, over the long term, when you compare fund costs directly. What you lose upfront, you gain in pygmy-sized TERs. And the effect becomes more pronounced over time.

Though upfront fund costs should be taken into account, ultimately it’s the dealing fees that are make or break. Use the fund cost comparison calculator to help you decide whether Vanguard works best for you.

There’s no doubt that UK passive investors are faced with slim pickings compared to US coach potatoes when it comes to low cost index funds. But we were practically on prison food before Vanguard arrived.

Vanguard has given the market a shot in the arm, and if trackers are part of your mix, you owe it to yourself to take a look at its range.

Take it steady,

The Accumulator

Update note: This article was updated in mid-December 2012 to take account of the many developments since Vanguard first arrived in the UK. Comments below may refer to out-of-date information, so check the date of commenting!

  1. Comparison of fund costs versus nearest index fund rival. []
  2. Again, comparing fund costs with the nearest index fund rival. []
  3. You’ve seen this movie before. []

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{ 121 comments… add one }
  • 50 Greg December 14, 2012, 10:19 am

    @Lookahead – You can buy fractional sizes with OEICs / UTs.

  • 51 Lookahead December 14, 2012, 12:14 pm

    @Greg – Thanks for letting me know that it should be possible.

    Unfortunately with TD’s regular investment setup page I get a ‘System error has occurred’ message asking me to try again later if I enter an amount less than the price of 1 unit of a LifeStrategy fund (~£110).

  • 52 Greg December 15, 2012, 3:14 pm

    @ Lookahead – Hmm. Send them a support request e-mail. They are pretty good at responding to them.

    I’ve just noticed that TD are now offering a number of ‘unbundled’ (i.e. with the kickback stripped out) active funds too, e.g. from IP and Fidelity. This confuses me more! How can they make any money?

  • 53 Jackie t December 15, 2012, 6:58 pm

    TD do seem the cheapest for vanguard with ISA – however they charge a £50 + admin fee for closure / transfer. Still if held for 2+ years one would expect bets HL platform fees. And guess they have to make money somehow.

  • 54 The Accumulator December 15, 2012, 8:37 pm

    If you’re with TD then you will beat HL from day 1 in a regular investment ISA. That transfer rate isn’t uncompetitive, btw. HL, for example, charge £24 per holding to exit.

  • 55 ivanopinion December 17, 2012, 11:13 am

    TD charges an exit fee of £35 per holding, if you don’t transfer your whole ISA or if you are transferring from a Trading account (ie, unwrapped). It will be pretty costly to exit, if (when?) they start charging realistic fees for funds that pay them no commission.

  • 56 Trevor Dewhurst December 17, 2012, 3:32 pm

    Hi guys,
    thanks for the fund infos and this website.
    I`ve now purchased my first 3 funds (basically cheap HSBC, gilts and trackers) and I`m now planning a move on the Lifestrategy funds. Quick question… is there any update on the TD platform fee for Vanguard Lifestrategy funds?

  • 57 Nick December 17, 2012, 9:37 pm

    @Greg some providers seem to be charging nothing on these funds for now, whilst waiting for the FSA to clarify their rules on commission for online-only providers. Saxo is another example.

    Of course, it’s unlikely they’ll offer funds for free forever, because as you say they won’t make any money. So the kicker here is the exit charges. When they do start charging, how much will it be and how much will it cost you to go to a cheaper alternative? That’s the difficulty for people looking at providers who currently charge nothing for these funds.

    The alternative is to go to providers who offer the funds but currently charge a realistic price for them. iii and AT have RDR-ready pricing structures (meaning they won’t have to change if/when the FSA bans commission for online providers.) TD, HL and Saxo (and many others) do not.

  • 58 The Accumulator December 17, 2012, 10:22 pm

    Currently it will cost me £50 to get my funds out of a TD ISA. Or I can pay AT £48 for the year (plus dealing fees) or iii £80 for the year (plus dealing fees). So the exit charges pay for themselves if I have to move in 12 months time. That’s assuming I have to move at all. If TD put their prices up in 6 – 8 months time then there’s every chance their charges are no worse than anyone else’s. In which case, I can stay put. So for now I think it’s reasonable to plump for TD and enjoy paying no fees for as long as it lasts.

  • 59 Nick December 18, 2012, 12:03 am

    @The Accumulator yup, that works.

  • 60 ivanopinion December 18, 2012, 9:47 am

    I agree that the exit charge for an ISA is pretty low. Seems worth the risk.

    But for a Trading Account, £35 per fund is pretty steep. My kids both have small Trading Accounts with ATS, so I would like to switch to TDD to save the £48 pa fees. But if I switch to TDD and they bring in unacceptably high annual fees, it will cost £140 to exit, so there will be an overall loss unless TDD keep their fees low for more than 2 years.

  • 61 john December 22, 2012, 9:06 pm

    Are there trading costs involved at TDD. I’m looking to set up a Vanguard LifeStrategy with an initial amount of 5.1k and drip feed via d/d of £50-100 a month. Would I be better off trading quarterly if there is a trading fee?

  • 62 The Accumulator December 24, 2012, 8:41 am

    Hi John, there are no trading fees at TD for the LifeStrategy funds.

  • 63 john December 24, 2012, 12:03 pm

    Hi Accy,
    TD got back to me and said ‘if you were purchasing one of the UK Vanguard life strategy funds then there would be no initial trading commission. The fund is subject to a annual platform fee but all or part of this is usually refunded if we receive a trail commission from the fund manager.’ I thought there was no annual platform fee? I also thought that Vanguard didn’t give trail commission to brokers?

  • 64 The Accumulator December 24, 2012, 2:09 pm

    John, you are right, Vanguard don’t pay trail commission. See TD’s published charges: there is no platform fee payable on funds that pay trail commission of less than 0.5%. Sounds like you’re being given a generic line. See this link:


  • 65 Trevor Dewhurst December 26, 2012, 7:06 pm

    Hi all,
    woke up Christmas morning having a look at my first portfolio on TD Direct and discovering… I`ve already made £2.39 on my HSBC FTSE 250 Index Accumulation C, UK Mid-Cap Equity within 3 days!! Hahaha. But then I was like… WHAT??? I spent weeks researching, reading filings and fund reports and what not… thats what I get in return????? Anyway, just joking 🙂

    1. Quick question… I`m currently looking at Vanguard US Equity Index Acc, Price: GBP 173.50 vs HSBC American Index Acc C, – Price: GBP 2.11. Does anyone know why there is such a wide spread of unit prizes for such a similar (tracking S&P 500) Fund?

    I couldnt really get my head round this…

    2. Question seems like BlackRock are neither offering an ISA-option, nor a discount of the 5% initial charge for the BlackRock Emerging Markets Eq Tkr A Acc (ISIN: GB00B65W2626). Does anyone know of an alternative (without having to go to L&G)?

    cheers and merry Christmas and happy new year to all of you
    thank you for this page (a treasure trove for passive investors) and the knowledgeable comments… :-))


  • 66 The Accumulator December 31, 2012, 11:12 am

    What a Xmas morning treat. All I got was socks 😉 I believe the unit price difference is explained by the number of units in circulation for each fund.

    Alternative emerging market trackers are Vanguard’s index fund (VIEMKT) or you could try an ETF, e.g. VFEM.

    Were you able to purchase your Royal London tracker in the end?

  • 67 Trevor Dewhurst December 31, 2012, 7:43 pm

    Yeah. I`ve gonne on to buy an emerging market ETF (they`re quite difficult to find on the TD website).
    And also the Royal London FTSE…
    Cheers. have a successful 2013
    (looks like 2013 is the first year with 4 different digits since I was born (1987).

  • 68 Joonatan January 4, 2013, 12:44 pm


    Do you know if there is a way for a non-UK resident to buy the Vanguard funds? I’m quite interested in the Vanguard Global small cap fund, but buying it is complicated from Finland ….


  • 69 The Accumulator January 4, 2013, 2:07 pm

    I’m sorry Joonatan, I don’t know the procedure for doing that. It would be great to hear from any readers who have experience of this.

  • 70 Trevor Dewhurst January 6, 2013, 9:46 am

    Hi Joon,
    its not complicated. open a British bank account and then do Onlinebanking from your internet in Finland.

  • 71 Joonatan January 7, 2013, 8:21 pm

    I’m mostly interested in the Vanguard Global Small Cap index fund, as it’s impossible to find a Global Developed markets small cap etf.

    I’m planning to buy four times per year, with a sum below 300£ (or twice a year with a larger sum). Time of investment is 20 to 30 years, so all costs should be minimal…
    Could you recommend a bank? 🙂

  • 72 Joonatan January 12, 2013, 1:26 pm

    By banks, do you mean platforms such as Interactive investors, etc. ?

    Would be happy if you could recommend a cost-efficient bank in the UK or give a clue how to find one.

    I’m currently trying to figure out if it’s better to handle small-cap investments with ETFs or with index funds (no small cap index funds are available in Finland). To be able to make a decision, I should find out what the banking costs in the UK would be.

    Cheers! Hyvää viikonloppua!

  • 73 The Accumulator January 12, 2013, 2:15 pm

    Joonatan, if Trevor means a regular bank then there really isn’t much to choose between them, at least from the perspective of a British resident. Banking is generally free in the UK, by which I mean you don’t have to pay to run a basic current account / savings account. Costs are generally recouped by opaque methods like charging high fees for overdrafts. I suppose certain banks may well be more competitive in the costs they charge overseas customers but then you’d be best placed to judge that.

    First Direct (a spin-off from HSBC) have the best customer service in my experience.

  • 74 Steve W January 15, 2013, 10:51 am

    Well I was about to set up a new ISA for my wife following on from some of the positive comments about TD Direct. However it would seem that the process of “Confirmation of Verification of Identity” is somewhat cumbersome. The options are either to go to their offices in London with passport etc or have an FSA Regulated firm verify the ID, which could involve the bank / solicitor completing one of their forms and no doubt charging me accordingly. Both my wife I have accounts with H&L and AT and previously just had to send utility bills and our NI numbers. Has the process changed for all platforms or is this just particular to TD Direct.

    ps. Just love your blog

  • 75 Nick January 15, 2013, 12:22 pm


    Providers normally ask for this kind of verification if the electronic tests fail (most providers have linked with companies like Experian to carry out identity verification electronically, and only ask for paper documentation if Experian can’t verify someone’s identity electronically.) It sounds like perhaps whoever TD use to provide identity verification weren’t able to verify your identity electronically.

    Some firms accept verified copies which have been signed e.g. by your bank manager, which might be easier than visiting their offices. Worth checking perhaps.

    PS. as posted on another thread here, TD have announced that from August, they will charge a 0.35% platform fee. http://www.tddirectinvesting.co.uk/investment-choices/funds-unit-trusts-and-oeics/funds-pricing/

  • 76 Steve W January 15, 2013, 5:26 pm

    Thanks for info Nick although guess I will be staying where I am now that they have issued the o.35% platform fee.

  • 77 Joonatan January 16, 2013, 4:23 pm

    Ok, thanks! Trevor, could you precise if you ment a regular bank?

  • 78 The Accumulator January 16, 2013, 10:42 pm

    Good point, Nick. Breakevens on the 0.35% platform fee:

    Alliance Trust @ £48 annual charge = £13,714

    iii @ £80 annual charge = £22,857

    HL @ £24 annual charge (1 fund portfolio) = £6857

    Portfolio values below these breakeven rates are better off at TD (in a regular trading ISA).

    There are dealing fees to account for at iii and Alliance Trust too. Estimate your likely annual dealing fees and add them to the annual charge / platform fee.

    Then the calculation is: Total costs / 0.0035 = £break-even

    The breakeven figures are for a portfolio holding clean-priced index funds in a single account. If you hold two accounts (e.g. you and a partner), the breakeven point for ATS and HL doubles.
    If you hold more than one tracker in HL, multiply the breakeven point by the number of funds.

  • 79 YC January 16, 2013, 11:12 pm

    I was wondering about the TER on LifeStrategy funds: these being funds-of-funds, is the TER of the underlying funds taken into account in the quoted TER? Or should we expect to pay ~.3% to the LifeStrategy manager, and another .3% to the managers of the funds held?

  • 80 Trevor Dubois January 18, 2013, 3:36 am


    Firstly, I’d like to say that, The Accumulator, you are doing a fantastic job educating individuals on the virtue of passive investing and indexing, and in particular, what you do that is unique is that you apply this method of investing to the UK public. I have read a few books and all the information I realised, as it applies to the US, is in many cases not very relevant to UK investors (for example, having super low Vanguard expense ratios and investing in a large choice of mutual funds / OEICS). I think you should consider writing a book because I would buy such a book!

    I want to get your opinion Accumulator – or anyone else who is has is happy to share their ideas. After reading some of the articles on this brilliant website, I’m not certain what strategy would be apply to me. I would want to take the approach of regularly investing any left over cash in a fund (thus small and frequent contributions) in an ISA shares account and I would want to rebalance whenever an asset would become relatively over-represented.

    Thus —> which broker / online platform would be cheapest (as that’s what good old Bogle has taught us to look for) for an individual looks with the following criteria:
    – regular investing of small amounts (thus I’m ETF’s might not be convenient)
    – regular rebalancing
    – many funds held – maybe 10 or more

    From the article entitled “hargreaves lansdown introduces platform fee” (although somewhat dated), I would hazard a guess that TD might be a good choice or Interative Investor. I would appreciate help on this.

    Many thanks

  • 81 The Accumulator January 18, 2013, 9:34 am

    YC, it’s all in. Vanguard don’t play that game. It’s just the initial fee and the TER that you’ll see on their website. You will pay some kind of platform fee to your broker too.

  • 82 The Accumulator January 18, 2013, 10:08 am

    @ Trevor – thanks very much for your kinds words. The best book I’ve found on passive investing with a UK focus is Tim Hale’s Smarter Investing. It’s well worth reading for a thorough grounding in the principles even though some years out of date in terms of fund choices.

    This piece is still reasonably up to date for broker choices: http://monevator.com/no-fee-discount-broker-options/

    Make sure you read the comments though for the latest developments. TD is a good choice if you’re likely to stay under the £13K breakeven (mentioned in the comments above) versus Alliance Trust for some years. If you’re not bothered about Vanguard funds then Cavendish Online is also worth looking out.

  • 83 Daniel January 20, 2013, 10:36 pm

    I have maxed out my 3% Halifax cash ISA for the last two years but the rate drops to a ‘not even keeping up with inflation’ level at the beginning of March. I am considering putting some/all of the cash into a Vanguard 60 Life Strategy fund. Mathematically, which is the best way to put the money in? Should I dump as much in as soon as possible – so that’s half now and the rest in April? Or should I pay it in monthly to spread the up and down effect of the market?


  • 84 The Accumulator January 21, 2013, 10:12 pm

    Hi Daniel, studies suggest that going all in is most profitable. However, many people find drip-feeding psychologically more comfortable. I certainly fall into this camp. Sadly, all the studies in the world can’t actually predict the market conditions that will prevail when you do invest.

  • 85 YC January 22, 2013, 2:21 pm

    @The Acc.: thanks, yes, I get it now. At first I didn’t really trust the documentation Vanguard provide, because they use AMC/TER interchangeably, so I thought they were trying to confuse the reader. But now I realise they actually equate AMC=TER, which is of course very commendable.

    As for going all in, would you have any pointers to the literature? I’d be quite interested, because it makes life very simple if one can get it all sorted in a single yearly transaction. Thanks!

  • 86 Nick January 22, 2013, 3:48 pm

    @YC: for all (mutual) fund-of-funds (active and passive), the TER should include the cost of the underlying funds.

    This applies to (mutual) funds, but I’m not sure whether it holds for ETFs.

  • 87 The Accumulator January 22, 2013, 8:26 pm

    @ YC – spot on about the Vanguard nomenclature. Re: drip-feeding vs all in, here’s a good piece by Larry Swedroe: http://www.cbsnews.com/8301-505123_162-37843026/dollar-cost-averaging-does-it-produce-better-results/?tag=mwuser#ixzz1bARC5p2X

    He links out to academic papers that have studied the problem in more depth.

  • 88 Newtothis January 24, 2013, 3:04 pm

    In case this might help anyone else.. (I’m new to all this but enjoying the Monevator education!) I recently tried to transfer a Vanguard Life Strategy fund in a stocks and shares ISA from Hargreaves Lansdowne to TD Direct in order to save on the HL platform fee (before TD introduced their new fee). My ISA is worth under 5.1k but I was setting up a regular investment and thought that information on their website (and the person I spoke to on the phone to double check) had said there was no charge for holding a regular investment ISA with TD, even under 5.1K. I found out by chance when I rang to query something just before sending off the transfer form that there is a £30 +VAT charge for holding the ISA, even with regular investment, and so I closed the account in time. Just posting this in case anyone else gets caught out although I may be more muddle-prone than the average reader 🙂 Thanks for all the amazingly useful advice here.

  • 89 The Accumulator January 24, 2013, 9:25 pm

    Hi Newtothis, the exemption from the £30 charge does exist but only after Feb 1. Your ISA must be valued at £5100 or above to avoid the charge before this date.

    You are quite right in thinking you’re better off with HL, however, given TD’s announcement about their platform fee.

  • 90 YC January 25, 2013, 6:40 pm

    Thanks for the Swedroe link, very worthwile!

    As for comparing between HL and TDD, note that HL have a .5% annual management charge (capped at 45gbp) which only applies to their ISA and SIPP offerings, so there may be a small bracket just upwards of 5100gbp where TDD are cheaper… nothing worth switching platforms for though!

  • 91 ivanopinion January 25, 2013, 8:18 pm

    I think the academic study on which Swedroe bases his article has a major flaw, which is that it disregards the fact that if you spread your investment over the next 12 months, you have part of your cash still available and so it can be used to earn income. For instance, you could have the money on instant access deposit or short-term deposit. The cash balance gradually declines over the 12 month period, so on average this is virtually the same as having an extra six months of interest on the cash.

    On the basis of the figures here: http://swanlowpark.co.uk/bank0604.jsp

    the average savings interest rate over the last 52 years is 6%. But the figures on that website are just the average for each year, and if you are only getting the average rate, you’re a bit stupid or lazy. We all know that if you bother to look, you can find rates that are significantly higher than the average high street bank or building society is offering. So let’s assume that if you were operating a drip feed strategy you could on average have earned interest of 8% per year, so six months of interest would be 4%. On the starting $1 million, that would mean the dollar cost averaging option would earn an extra $40,000. That would wipe out most of the supposed outperformance of the lump sum investment option.

    Nevertheless, it is difficult to conclude that pound cost averaging or dollar cost averaging is a better strategy than investing the money as soon as you have it, contrary to the advice you see peddled extremely widely by “experts” all over the place.

  • 92 The Investor January 25, 2013, 9:12 pm

    Interesting discussion. 🙂

    Nevertheless, it is difficult to conclude that pound cost averaging or dollar cost averaging is a better strategy than investing the money as soon as you have it, contrary to the advice you see peddled extremely widely by “experts” all over the place.

    In my view it’s better to invest it as soon as you have it provided you can take the emotional risk that the market might be 5/10/30% cheaper in 2/3/6 months time (or worse). Averaging in a big lump sum is about psychology, not about getting a better return, in my view.

    In my experience, most people get extremely upset if their investment loses 20-30% and it represents most of their wealth / a meaningful sum to them — perhaps more than they thought they would. (I don’t particularly, as long as it’s the whole market moving not some stupid thing I’ve done, but I seem to be pretty unusual in that regard, and maybe I will too when I’m older…)

    If I was an IFA (which I’m not!) I’d probably suggest they average into the market for that reason, too. It’s an insurance policy.

    As I see it, pound cost averaging turns volatility into an advantage if you’re a regular saver and the market goes up over the time you’re averaging in. To my mind it’s really more of a nice thing to remember when you’re a new investor facing market volatility and you’re saving regularly and are a bit worried, rather than a strategy to get an edge.

  • 93 ivanopinion January 25, 2013, 9:33 pm

    I think you are right. If an adviser suggests investing everything right away, and then the market falls, the client can easily see the “loss” they have made and they get very upset with the adviser. However, if the adviser suggests spreading the investment over 12 months and the market steadily rises, it isn’t quite so obvious to the client that they have made a loss in comparison to what would have happened if they had invested right away.

    However, that’s just faulty thinking. I can understand why advisers and many investors prefer pound cost averaging, but that’s not the same thing as saying it is the smart strategy. For decades now I have been reading that PCA is a better approach because it will increase your returns. Turns out it is completely wrong.

  • 94 The Investor January 25, 2013, 9:58 pm

    Hi again 🙂

    However, that’s just faulty thinking.

    Hmm, well, it’s not only faulty thinking is it?

    What if (for example) by averaging in a lump sum my maximum return over some period is 20% and my largest possible minimum return (i.e. drawdown) is minus 10%. Whereas investing all in at the start could deliver (for example) a maximum return of 30% but the potential for minus 20%, over some arbitrary period?

    Many people — perhaps most — would rather take the smaller maximum return as the price of not risking getting whacked with the larger potential drawdown of 20%. They would rather not risk losing more money, at the cost of the chance of earning more. I think that’s rational for some/most.

    Of course I’ve just made those numbers up — the whole snag about the future is we don’t know what’s going to happen! But swapping maximum reward to reduce risk *is* I think a worthwhile trade for many.

    I have been reading that PCA is a better approach because it will increase your returns. Turns out it is completely wrong.

    As a definitive statement like that, I agree with you.

    It *might* increase them or it *might* reduce them. You cannot know in advance. If my aim is to maximise my *chance* of the biggest possible gain, I think it’s best to go in ASAP. This is almost entirely because markets tend to rise over time, I think.

  • 95 ivanopinion January 25, 2013, 10:37 pm

    We don’t know what will happen, but we do know the odds, based on long-term historical trends. The research referred to by Swedoe used back testing to look at every possible period of 12 months dollar cost averaging since the beginning of 1926. That’s just over 1000 different scenarios. And they found that simply investing a lump sum at the beginning of the 12 month period gave a better outcome in 71% of cases. What’s more, in the 71% of cases where the lump sum outperformed DCA, the outperformance was, on average, higher than the underperformance in the other 29% of cases.

    So lump sum gives more than double the chance of a bigger reward. Swapping maximum reward to reduce risk might indeed be a worthwhile trade, but the evidence shows that that’s not what pound cost averaging does.

    I didn’t mean literally that the fans of PCA/DCA have ever suggested it is guaranteed to give the best returns. But they have suggested that it improves your chances of a better outcome. They are wrong. It does the exact opposite.

  • 96 The Investor January 25, 2013, 11:27 pm

    Swapping maximum reward to reduce risk might indeed be a worthwhile trade, but the evidence shows that that’s not what pound cost averaging does.

    I may be misreading you, but I think you’re misunderstanding me. 🙂 You seem to be saying that because the potential higher return is greater than the potential underperformance, it hasn’t reduced risk on balance. In aggregate that might well be right. But an individual investor only goes through life once, he doesn’t get the average of all outcomes but rather takes the hand s/he’s dealt. And you will certainly do worse investing all in at the start if markets are falling.

    Sometimes markets go down. If you invest over a period when they are going down, you’d do better not to invest all at once, but rather invest periodically. The maths cannot be otherwise.

    E.g. Imagine the market starts the year at index level 10,000 and ends at 4,000, falling by 500 every month. We’ll ignore both dividends and interest on un-invested capital for simplicity, assuming they net out.

    Scenario A: You invest £10,000 at the start of the year. At the end you have £4,000.

    Scenario B: You invest £833.33 at the start of every month throughout the year. According to my quick spreadsheet you have £5,869.98 at the end of the year.

    Clearly, the last £833.33 was only exposed to one month of falls, the second to last only two, etc. Whereas the 12x£833.33 invested at the start with strategy A got all 12 months of falls.

    You can’t know what *will* happen over any given period, but there will be times when a market falls over your contribution period, and if you could know one of those times were approaching, it would be better to invest monthly.

    In fact, if you could know it would be better not to invest until the falls were over! 🙂

    Again, this is different from saying you’d rather a strategy that optimises your chances of superior returns. Markets tend to go up, so a strategy that capitalises on that will likely do better.

    But if you’re more risk averse than returns orientated, it might well make sense to average in to reduce the risk of taking greater losses, as shown above.

    p.s. It’s late and I had a couple of pints earlier, but I think the maths is good. 🙂

    p.p.s. I also just realized that I haven’t read the start of this thread, so we may be discussing slightly different things. I am discussing the classic: “I have £100,000 (say), should I invest it all at once?”

    Everyone else has no choice really but to invest regularly and cost-average in, because we must save out of spare income, surely?

  • 97 ivanopinion January 26, 2013, 11:47 am

    Well the thread started as a discussion of Vanguard, but it has developed a very interesting sub-topic which is, as you say, about whether you should you invest a lump sum at once or spread it. I always thought the rationally smart thing to do was spread it, but this academic paper proves the opposite. [However, if instead the question is whether someone who has regular surpluses of income should invest them regularly or save them up and then invest later as a lump sum, I agree that regular investment is better. The principle should be that you should always invest as soon as you can (assuming the amounts are big enough that trading costs don’t distort the decision).]

    We both agree that if you know the market is going to fall you should not invest all at once, but I’m pretty sure you would also agree that there is no way to know this. So in the real world, you have to take a risk. Whether you choose upfront or spread, there is a risk that it might turn out that the other choice would have performed better. The extent of the risk is indicated by long-term historical experience.

    You appear to be suggesting that pound cost averaging is, somehow, a lower risk option than upfront lump sum, but as far as I can see the academic study says it is higher risk.

    Your example figures, under which PCA leaves you £1869 better off, are something that might happen, but they are unlikely. There’s only a 29% chance that PCA will leave you better off than lump sum and the amount by which you are better off is likely to be relatively small. There is a 71% chance that PCA will leave you worse off than if you had chosen lump sum. And what’s more, on those times when it does leave you worse off, the amount by which you are worse off is likely to be bigger.

    So PCA does not reduce the risk of taking greater losses; it increases this risk.

  • 98 The Investor January 26, 2013, 2:11 pm

    @ivanopinion — What we agree on: For most people trying to amass a larger capital sum, invest whatever you are going to invest as soon as you can invest it. 🙂

    My example figures aren’t unlikely. From memory, the market goes down something like one year out of every three. So quite often you’d have done better to wait. But we are agreed — it’s a hobbled strategy, since we don’t know which year it will go down. 🙂

    My main point is that PCA is of psychological benefit. I wouldn’t argue that anyone saving over the long term should do it for financial reasons, because of all the things we’ve discussed.

    Off to get some sun now! 😉

    p.s. I just realised you’re right they are ‘unlikely’ in that 1/3 is less than 50/50. From the point of view of emotions and investing, though, an event that happens roughly one in every three years is not unlikely, I’d say — it’s of consequence *emotionally* speaking.

  • 99 ivanopinion January 28, 2013, 6:43 pm

    You are right, I meant unlikely in the sense of less than half as likely as the alternative, which is that the upfront lump sum outperforms PCA.

    I really don’t want to argue, but I don’t understand why you only seem to be concerned about the emotional impact of the one third chance that upfront lump sum might underperform PCA. Isn’t there also an emotional impact of the (roughly) two thirds chance that if you choose PCA it will turn out that you would have been better off choosing upfront lump sum?

    Choosing PCA would only make sense if you ascribe a greater weight to avoided losses than to forgone profits. That is, if you prefer to forgo a 71% chance of extra profit of, say, 100, because you don’t want to take a 29% chance of extra loss of, say, 80 (I don’t know the exact figure, but I know it would be less than 100).

    However, if you are so risk averse, you really shouldn’t be making investments at all; you should stick to government guaranteed savings accounts and fixed interest bonds.

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