The Investment Company Price War and the Thrift Savings Plan
The three largest investment firms are Vanguard, Fidelity, and Schwab. Vanguard has been the low-cost leader in the industry, but recently Fidelity and Schwab have been lowering the cost of their index mutual funds and exchanged traded funds (ETFs) in a kind of price war. In some cases, Vanguard is no longer the low-cost leader. How does this price war and the resulting costs compare to the Thrift Savings Plan, which has also had historically low costs on their investments? Let’s find out…
Vanguard’s S&P 500 Index Admiral Shares Fund has an expense ratio of 0.04%. Remember that the expense ratio according to Investopedia is “a measure of what it costs an investment company to operate a mutual fund.” In other words, if a fund you own rises 10% in a year, but the expense ratio was 1%, then you only get to keep 9%. The lower the expense ratio, the more of your investment gains you get to keep. If the Vanguard S&P 500 fund goes up 10%, you get to keep 9.96% of it.
When I went to Schwab’s website, their site said, “Think Vanguard has the lowest costs? Think again.” They tout, “Schwab market cap index funds and ETFs are up to 80% less than comparable funds at Vanguard and 70% less than Fidelity. Everyone pays the same—Whether you have $5 or $5 million to invest, you get the same low cost for Schwab market cap index funds.” Here is a comparison chart on the S&P 500 index funds:
Figure 1. A comparison of the cost of the S&P 500 index funds at Schwab, Vanguard, and Fidelity. (Source)
As you can see, the Schwab fund is cheaper. In addition, in order to get into Vanguard’s Admiral share class and get the lowest cost, you need to invest $10,000. At Schwab, everyone gets the lowest cost shares. You’ll notice as well that Fidelity’s funds are all cheaper than Vanguard’s.
How does the TSP compare? If you go to the TSP page that discusses their expense ratios, you’ll see that the average expense ratio for all their funds in 2016 was 0.038%. The C Fund is the equivalent to the S&P 500 funds discussed above, so you can see that the TSP’s expenses are slightly above Schwab and Fidelity and just below Vanguard.
Why are these companies in a price war? Does this mean that Schwab and Fidelity are the new sheriff in town and Vanguard, where I do all my investing outside of the TSP, should be put out to pasture?
The same thing has happened in the past with brokerage commissions you pay when you trade a stock or ETF. While it used to cost $50-100 to execute a trade over the phone, now they are less than $10 and often free. This is the evolution that occurs in a free, competitive market.
Part of the reason for this price war among Vanguard, Fidelity, and Schwab is that investors are moving billions of dollars from actively-managed funds, where fund managers are trying to beat the market, to index funds that passively track the market and are happy to accept whatever gains (or losses) it generates. Vanguard has been all about index funds since its inception and is practically synonymous with the term “index fund.” Schwab and Fidelity are doing everything they can to get investors in the door, even potentially operating these funds at very low profit margins or even at a loss.
Should everyone investing at Vanguard or somewhere else switch to Schwab or Fidelity? I’d argue no for two reasons.
First, the difference between a 0.03% expense ratio at Schwab and a 0.04% expense ratio at Vanguard on a $1 million portfolio is only $100. On $100,000 it is only $10. In other words, we are talking about small amounts of money relative to the overall size of the portfolio. If you try to switch companies outside of a tax-advantaged retirement account, you will have to pay taxes on any gains you have. Even in a tax-advantaged account like an IRA, you will have some administrative pain to bear and forms to fill out. We have enough of that in the military as it is. If you keep your old accounts and just start fresh with a new company for any future investments, now you have more accounts at more institutions that you need to track, complicating your financial life. To me, it is not worth it. Simpler is usually better.
Second, while Schwab and Fidelity are lowering expenses on their most popular index funds, Vanguard has a unique structure. It is owned by its shareholders. This makes it equivalent to a non-profit investment company, and ensures it will have low costs across the board no matter what product you are looking to invest in. For example, the Vanguard Target Retirement 2030 fund has an expense ratio of 0.15%. The equivalent at Fidelity, the Fidelity Freedom 2030 fund, has an expense ratio of 0.7%, which is more than 4 times more expensive. Schwab’s Target 2030 Index Fund has an expense ratio of 0.08%, lower than Vanguard’s. The TSP’s Target Retirement 2030 fund is lumped in with all the rest of the funds they offer and has the same expense ratio of 0.038%, lower than all of the other companies’ equivalent funds.
What’s the bottom line? This price war among Schwab, Fidelity, and Vanguard benefits the investor as costs come down. All three are large, well-established companies managing trillions of dollars, and you can likely do well investing with any of them if you know what you are doing. The TSP remains a low cost leader across the board no matter what investment you pick.
Will I switch from Vanguard for all of my non-TSP investments? No, because I know that no matter what investment I pick at Vanguard the cost may not be the lowest, but it’ll be among the lowest in the industry.