Why I Invest with Vanguard

I’m currently reading (and, of course, enjoying) John Bogle’s recent Enough. One question Bogle raises in the book is this: Which do you think is more important to most mutual fund companies: The return on their capital, or the return on their clients’ capital?

I like the way Dave phrased it a couple weeks back:

The purpose of the financial services industry is to make themselves rich, while making their clients “rich enough.”

Agreed. I suspect that the primary goal is to increase the profits of the fund company and that, as long as their funds are doing well enough that the clients don’t start switching to other firms, the company is happy.

So what?

At this point, the reader may ask, “Well, sure. But why is that so bad? Isn’t every company’s primary goal to make a profit for its owners?”

For the most part, yes. But I think that line of reasoning misses two important points:

1. They’re breaking the law.

The Investment Company Act of 1940 states that investment companies (such as mutual funds) must not be:

“Organized, operated, [and] managed…in the interests of directors, officers, investment advisers, depositors, or other affiliated persons…rather than in the interest of all classes of such companies’ security holders.”

In other words, fund companies are required by law to put their clients’ interests before their own. Sadly, this rule appears to be blatantly disregarded by fund companies and unenforced by regulators.

[Tangential pondering: How long would a doctor keep his license to practice if it could be conclusively shown that more than 50% of his clients would have been better off having never utilized his services? For 30+ years, we've allowed various fund companies--and, for that matter, the entire actively-managed fund industry--to operate, despite the fact that we can conclusively show that more than half of their clients would have been better off without them.]

2. Why not avoid the whole mess?

More to the point for the individual investor, though, is this: Why would you choose to invest via a company that puts your interests second when there is a company that truly does put its clients first?

In case you don’t know what I’m talking about: Vanguard has a unique ownership structure such that the company is actually owned by the people who invest in their funds. (That is, the clients are also the owners.) As a result, the conflict of interests described above is eliminated entirely.

In other words…

• Unlike every other fund company, Vanguard is owned by its clients.
• Vanguard has consistently been the lowest cost fund provider throughout the last three decades.
• Vanguard’s funds repeatedly dominate the competition in their respective asset classes.

I suspect that those three facts are somehow related.

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