When it comes to investing, it’s easy to get distracted by the “sexy” stuff.
There’s a lot of it about: driverless cars, cryptocurrencies, all-time highs, multi-baggers, artificial intelligences that’ll beat the market for you, then thrash you at a game of Go afterwards.
I love all that. Love reading about it, love thinking about it, love writing about it, and, yes, I love to take a punt on it too.
But there’s one really boring thing that, in the long run, could make you a lot more money than any of that lot. Better yet, it’s something that you have complete control over.
I’m talking, of course, about cutting your costs.
And something big happened this week that could make it even more profitable than ever before for UK investors…
The passive behemoth lands in the UK
When it comes to investing, Vanguard – the second-biggest wealth manager in the world (only behind Blackrock) – is the king of cost-cutting.
Founder Jack Bogle created the first index fund, back in 1976. His insight was that it’s very hard for active managers to beat the market. Put simply, investors as a group can’t beat the market, because they ARE the market. And in fact, this means that investors – as a group – must underperform the market, because investing costs money.
So in a reasonably efficient market – one where there are lots of professional, well-informed investors trying to beat each other’s performance – it’s going to be very difficult for any one investor to come out on top consistently.
That’s the theory, and in practice, it usually works. Most active managers find it hard to beat the market, and picking one who does so consistently is extremely hard to do.
So, thought Bogle, if you can’t beat the market, just join it. Don’t worry about getting an above-average return – just get the average return. All you need to do is to copy the underlying market. And because that requires no stock-picking (though it does require other skills), the strategy can be run cheaply.
Wall Street hated it. They laughed at “Bogle’s folly”. Today, Wall Street – and the rest of the financial industry – still isn’t keen. But they’re not laughing. Not even nervously.
Passive funds are taking over. More and more investors have realised the wisdom of Bogle’s logic. But probably more importantly, they’ve realised that paying 1% a year more than you have to will have a truly dramatic impact on your finances over the long term.
In these days of low interest rates and theoretically low future returns, none of us can afford to lob away hundreds of basis points (a basis point is 0.01 of a percent) on fees for financial industry middle-men – certainly not if they don’t actually pay for themselves.
So that’s how Vanguard helped to revolutionise the fund industry. But it’s not the only area where they’re driving down costs.
This is a price war that you’re going to like – unless you own asset managers
You see, this week, Vanguard launched an investment platform in the UK. So you can now buy Vanguard funds direct from Vanguard. And it’s very cheap to do so.
Vanguard will charge you 0.15% a year on amounts up to £250,000. Beyond that, there’s no further fee. So the annual fee is capped at £375.
That compares extremely well with any of the other online brokers that charge a percentage fee. Hargreaves Lansdown – very popular with MoneyWeek readers – charges 0.45%, for example. To be fair, Hargreaves has never been the cheapest platform – the power of a solid brand and reliable customer service cannot be underestimated – but that’s an eye-catching gap nonetheless.
On the downside, you can so far only buy Vanguard’s own products on the platform. And a Sipp isn’t available yet, though one is coming in the next year, apparently. And as the Monevator blog points out, if you have a particularly large portfolio then you might still be better off going with a fixed-fee broker.
But if you do own Vanguard funds, this looks like an extremely cost-effective way to do it.
What does it mean for the wider market? The trend towards passive investing will only continue to grow. And the trend towards lower fees will carry on too. Regardless of the brave face being put on this by Vanguard’s rivals, this looks like bad news for their profits, and for the wider active fund management industry in general.
Vanguard isn’t some flashy “disruptor” with a beard and a big idea and a lifespan roughly as long as the average VC’s attention span. It’s an established monster of a business and it won’t go away – it’ll just keep growing. Credit ratings agency Moody’s reckons that everyone, from the newfangled robo-advisors to active managers such as Aberdeen and Fidelity, will feel the squeeze.
That’s a big win for you as an investor, of course. And I for one welcome our new passive management overlords.
But if you own shares in any of the big financial industry players, take a look at them, and ask yourself how convinced you are as to the sustainability of their profits and business models.