A couple of months ago, I wrote a piece questioning whether Vanguard’s systems were in danger of collapsing. It’s no secret that many investors are experiencing customer service issues. And I haven’t been shy about criticizing some newer products that Vanguard has launched. As a result, people are asking me if they should leave Vanguard.
It’s an individual decision on where anyone should custody assets. There is no doubt that one could custody at firms like Fidelity and Schwab and get better customer service, a much more intuitive web and smartphone app interface, while buying the same Vanguard ETFs without commissions. On top of that, some brokerage firms would pay me a handsome “acquisition award” if I transferred my holdings from Vanguard. So why am I staying put? In one simple word: trust.
The late Vanguard founder, John C. Bogle, once said, “No man can serve two masters.” He was referring to a financial fiduciary having to serve investors as well as owners. Vanguard is owned by its fund holders. Other firms have different owners. Schwab is publicly traded, while Fidelity is owned in large part by the Johnson family. When owners are not the investors, more conflicts of interest occur.
These conflicts aren’t just what might occur in the future; they are also about what they are doing today. A vivid example can be seen with cash. One advisor recently told me he “couldn’t help but notice the gap between the 0.01% yield on the Schwab sweep vehicle and the current 1.03% yield of the Vanguard Treasury Money Market Fund.”
He was referring to advised accounts and the change that took place after Schwab acquired TD Ameritrade. For those of us who invest in retail accounts, the difference is also huge with the following yields as of June 27:
Schwab Uninvested Cash: 0.15%
Fidelity FCASH: 0.69%
Vanguard Federal Money Market: 1.38%
Even with an average of $10,000 in cash, that amounts to earning as little as $15.00 versus $138 a year. With $100,000, the annual difference is $1,230. Schwab recently settled with the SEC to pay $187 million to clients of the robo advisory intelligent portfolio investors for failing to inform them on the cost of the cash drag.
Indeed, I would argue that Schwab is no longer in the investment services business. For the first quarter of 2022, Schwab earned 119% of its pretax income from paying investors peanuts on cash and then using that cash to earn more, according to the Schwab 10Q. It paid investors $136 million in interest while it earned $2.319 billion.
The rest of Schwab’s businesses in aggregate were money losers. Schwab is in the business of gathering cash. This is a similar strategy to HP selling printers below cost so they can then make large profits by selling ink cartridges.
Why does Vanguard pay so much more? Nafis Smith, head of taxable money market funds at Vanguard, told me, “Our [ownership] structure enables us to keep costs low, so that investors keep more of their returns. Vanguard is returning all of their earnings from cash, less the 0.11% expense ratio that Smith noted had declined from 0.33% two decades ago.
Vanguard also returns 100% of profits from securities lending to fund holders, while other firms don’t disclose what they do with the profits. One also has to wonder if for- profit firms are executing trades based on getting the best price for the investor or making the most money for directing order flow.
I’m not the only one who seems to trust Vanguard more. Vanguard is gaining ground on iShares ETFs. A fund family can raise its expense ratio, trapping money between paying capital gains taxes or staying on paying those higher annual fees. This happened to me when I started indexing in the late ’80s with Dreyfus and Fidelity. Dreyfus later raised fees dramatically, though Fidelity lowered them, and now has fees even lower than Vanguard.
My logic is that if I trust Vanguard more in the ETF space, I should trust them more to custody my money and not play games selling some products below cost while charging more on others in a nontransparent manner.
Now, in full disclosure, I also have a substantial Fidelity account, but it’s still a small fraction of what I have with Vanguard. And to be fair, I’ve always seen Fidelity do the right thing, as noted with my original Fidelity S&P 500 index fund.
Yet I wonder what any for- profit firm might do in really tough times. Finally, I also have a tiny Schwab Intelligent portfolio, but that was only because it’s the only way I could see what was underneath so I could write about it, and noted how much I disagreed with Schwab’s position on cash.
Only time will tell if my trust in Vanguard is well-placed or misplaced based on loyalty for everything Vanguard and its late founder has done for me and millions of consumers over the past few decades. I still wish Vanguard would concentrate its resources on fixing broken IT systems that I think are the root of customer service issues rather than launching newer, more expensive funds.
But I think Vanguard at least understands what needs to be fixed, and I am encouraged that they never seem defensive when I interview them and write about Vanguard issues. Vanguard is much more transparent on pricing and doesn’t seem to cross-subsidize by selling some products below cost and making it up with other products.
So, I’m sticking with Vanguard and hope to be writing a piece someday about how much things are improving.
Allan Roth is the founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for Barrons, AARP, Advisor Perspectives and Financial Planning magazine. You can reach him at [email protected]reToBeDull.com, or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter.