john bogle vanguard

“Disruption” is a term you hear bandied about in Silicon Valley, usually associated with young CEOs in t-shirts.

The idea isn’t new. The 19th-century industrialist Andrew Carnegie would recognize it as competition. Joseph Schumpeter, an Austrian economist from the 1930s, would call it “creative destruction.”

In finance world terms, my favorite version of disruption is “the Vanguard effect,” the inevitable drive toward low-cost investing led by the iconic John Bogle.

Disruption came to mind while I was watching a presentation on low-cost investing. It showed the average price of exchange-traded funds (ETFs) offered by State Street, the No. 3 provider of these market-tracking mutual funds after BlackRock and Vanguard.

The slide showed a collection of index-style ETFs sold by State Street, featuring asset classes you might expect to find in a normal retirement portfolio.

On average, the firm’s cost to investors for owning those funds — the funds’ expense ratios — had fallen from 16 basis points to 6 basis points. (On a portfolio worth $100,000 that’s a drop in fees from $160 to $60 per year.)

It seems like tiny numbers, but the difference is huge. A 62.5% decrease! When’s the last time you saw the price of anything fall by more than 62%? Talk about disruptive.

State Street is lowering costs because it’s chasing the $4 trillion and rising that has poured into the low-cost investing business over the past few years. BlackRock’s iShares products lead the way for now. Vanguard is gobbling down tens of billions a month.

How low can you go?

The co-founder of the investment group Dimensional Fund Advisors, John McQuown, recently predicted that even more money will pour into low-cost index investments.

“I don’t see why it won’t [continue],” McQuown told the Financial Times. “First of all it just has better results. And it has better satisfaction exhibited by investors.”

Bogle himself recently pondered the endgame of low-cost investing. Now retired, the pioneer of indexing wonders at what financial point costs simply can’t go any lower.

“There’s an irreducible minimum, no matter how big you are, just for the fun of it, 8 basis points, cost a lot of money to run this business,” Bogle said in an interview with Morningstar.

It’s entirely possible that someday soon index products will be free and that active fund managers will be unemployed. Many industries use so-called “loss leaders,” products sold at cost or below in order to get customers in the door. The $1 menu at fast food places comes to mind.

For those of us in the financial advising business, the falling cost of investing is actually great news. The mission of any registered investment advisor (RIA) is to act in the best interest of his or her client.

Lower cost is absolutely in the best interest of all investors. Jay Vivian, former managing director of the IBM Retirement Funds and a member of the investment committee of my firm, Rebalance, used to tell his clients that every basis point matters.

Costs add up

Vivian worked for engineers, people perfectly willing to wrap their heads around seemingly small factors. And a single basis point does seem very small.

Ah, but costs add up. Vivian would show IBM employees how every extra basis point — each hundredth of a percent — stretched over 30 years of investing could push a retirement date out by months!

Would you work an extra three months so that your financial advisor could make more? If presented to you that way, almost certainly not.

Yet many millions of investors continue to pay upward of 2% and even 3% of their investment balances — a cost of $2,000 to $3,000 per year in fees on a $100,000 portfolio — for returns that do not come close to justifying the expense.

You have to wonder where it all ends, if not zero. Any truly investor-focused advisor cheers falling prices. More money is more money, and it belongs in the pocket of the investor.

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