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 [1].
Not many fund firms have a fanbase but Vanguard [2] does. Its cheerleaders are the Bogleheads [3], disciples of Vanguard’s visionary founder John Bogle [4] – 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 [5] 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 [6] 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 [7]
- Emerging markets index fund – Vanguard is the cheapest.2 [8]
- UK Government bonds index fund – Vanguard is the cheapest.3 [9]
The only problem is that you can’t just roll up to any online broker [10] and start ordering Vanguard…
The Catch
[11]
Buying index funds used to be straightforward. You pick a fund from the investment platform of your choice and – if you choose wisely [12] – 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 [13] (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 [14] 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 [15]. 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 [16], 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:
- Alliance Trust [17]
- Sippdeal [18]
- Bestinvest [19]
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 [20].
Complications
Hargreaves Lansdown [21] carries the same (limited) fund range as TD Direct but there’s no way to duck its platform charges [22].
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).
Capiche?
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 [23]. 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 [24].
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 [25].
ETFs are subject to dealing fees and bid-offer spreads that make their bald TERs less advantageous [26] 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 [27] 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 [28] (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 [29] 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!