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

Updated by The Accumulator on December 11, 2012

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:

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.

Complications

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).

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. 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!

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

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Weekend reading: Festive fun

by The Investor on December 8, 2012

Good reads from around the Web.

I know my co-blogger The Accumulator has a cult following among Monevator readers, but I never expected to see a financial product bearing his own name.

Of course I can’t be sure the money-amassing Accumulator device was named in honour of our parsimonious comrade-in-arms, or even inspired by him.

You’ve got to admit though that this fancy tube for collecting £1 coins does fit his mantra – it’s simple, cheap to run, and it can be operated by any DIY investor who has a pulse and the ability to save the odd £1 coin when holidaying in Bognor.

But I’m not going to take this lunge for fame lying down, rest assured. If The Accumulator can have a low-tech saving vehicle, then I think it’s time I finally launched my eagerly-awaited hedge fund.

The Investor’s Massively Asymmetrical Risk-Arbitrage Diversified Holdings Unit will invest in literally millions of distinct assets, each with their own bespoke characteristics.

And I can guarantee that there will be at least some people who are made into millionaires by the operation of my new hedge fund. (These people will be shown off at fancy City gatherings in order to convince more lucky punters to get into this great opportunity).

Of course, I shall be taking the customary 2% off investors for getting out of bed.

I shall also be gobbling up the quaintly traditional 20% of any profit made by my investors.

And how will it work? Oh, you don’t need to worry about that. It’s a black box, isn’t it? Trust me, I’m a soon-to-be rich hedge fund manager!

Okay, as you’re a loyal Monevator reader, here’s the skinny: Every week I will round up my investors’ money into a specially selected asset class that I have selected for return characteristics that are completely uncorrelated to the stock market.

In short, I will spend everyone’s money on lottery tickets – after my 2% take, of course.

[continue reading…]

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Weekend reading: Are you one of the dying breed of gentleman investors?

by The Investor on December 1, 2012

Good reads from around the Web.

Here’s an interesting graph via Business Insider showing who owns the US stock market, and how that’s changed in the post-war period.

A few interesting things to notice – the still small impact of ETFs, the plateauing of hedge fund’s presence in the market, and the big retreat of pension funds.

But most revealing is the demise of ‘household’ ownership of equities:

(Click to enlarge)

It seems the individual investors who used to dominate ownership of the US market have largely thrown in the towel on buying shares themselves (although much of their allocation toward equities will now be in mutual funds).

When Warren Buffett was getting started in the 1960s, he was up against amateurs. Today any self-directed stock picker is playing against professionals.

For most people that’s a good reason to invest passively, but for one or two active diehards who think career risk dominates fund manager’s decision making, it might just be an opportunity. (The key word being ‘might’!)

DIY is RIP

Felix Salmon doesn’t see those private investors coming back. Writing for Reuters, the blogger notes that real money share trading volumes are still falling, as shown in this graph:

(Click to enlarge)

‘Real money’ is mainly what we think the stock market is about – someone making a decision to invest their money in a specific company – as opposed to passive flows from ETFs or the frantic shuffling of high-frequency traders.

And such volumes are way down.

Perhaps this is because everyone has become a long-term buy-and-hold investor, savvy about the perils of over-trading?

Hardly. Salmon is surely right when he ventures:

I think that what we’re seeing is the slow death of the stock-market investor — the kind of person who subscribes to Barron’s, idolizes Warren Buffett, and thinks of stock-market investing as a do-it-yourself enterprise.

During the dot-com bubble, lots of people thought they were really smart when it came to stock-market investing, and then after the dot-com bubble burst, the rise of discount brokerages helped encourage new people to step in to the market and try their luck.

But:

Nowadays the message is sinking in: it’s a rigged game, you can’t win, and you’re better off with a passive strategy.

I’d agree with that, except for his use of the word ‘rigged’.

And except for the fact that I do personally invest a lot of my money actively – even though I think passive investing is best for nearly everyone, very likely including me!

[continue reading…]

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Proof that falling share prices can be good for your portfolio

Updated by The Investor on November 30, 2012

Make peace with the markets zig zag ups and downs

When you’re investing in a bear market, it’s easy to forget that share prices can go up as well as down.

This daily volatility scares people off during bull markets, too. It can be hard to watch your net worth fluctuate according to the whims of Wall Street (which is one reason I believe it’s better to focus on your portfolio income).

At least this volatility is potentially making you richer – provided you’re trickling money in regularly over the long-term.

With so-called dollar-cost averaging, you buy more shares when they’re cheaper and less when they’re expensive. The volatility actually improves your returns.

Mike at Oblivious Investor created this three-minute video showing the maths:

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