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Tuesday, 27 June 2017

What's up with this 'Vanguard' thing

Have you heard of this 'Vanguard' thing? And you've maybe heard of index funds? If you've been around the early retirement sphere for a while you've probably stumbled across them. Unfortunately most bloggers seem to assume you know what that means.

I'm not going to pretend to be a tax expert, or a genius investor, but I'm going to give you a whirlwind tour of why I invest in index funds, and why I use Vanguard.

I heard about Vanguard way way back in 2013. I think. As a rough guess. I was reading Mr. Money Mustache blogs from start to finish (with the exception of the ones about the US tax code). After reading every post I was convinced I was going to retire by the time I was 30, that people in cars were clown, and that Vanguard was good.

I've since had to revise 30 up to 35, I'm willing to admit that cars are okay (although you really only need one in the house) but I still think Vanguard is pretty darn good. I started investing in it back in July 2015 before I really understood what I was getting into.

Pros: Low fees and a slice of every pie

That's one of the best parts about Vanguard - it's investing for dummies. You want to invest in the top companies in Australia (or the US, or the world?!) then Vanguard has you covered. Worried about stocks and you'd rather go for bonds - less volatility but a more secure return - you can do that with Vanguard. You want to invest in real estate but don't have the down payment for a property? With Vanguard you can buy into a massive real estate portfolio that includes residential and commercial properties for a measly $5,000. More than investing with Brickx, but you get actual diversification, a brilliant track record and really low fees.

Yay for Pie!

Investing for dummies? Pie?!

Yepp, investing through Australian Securities Exchange (ASX) is like getting a really big slice of the pie, without the tedious process of buying every single company listed on the ASX. You could also get a slice of the S&P 500 (America), a collection of Australian Government Bonds or a slice of the international market. For the sake of simplicity I'm just going to talk about buying a slice of the ASX.

When you buy a single unit of the Vanguard Australian Shares fund you buy a small piece of their portfolio. Each piece goes up and down in value based on the companies within it, and you receive a portion of the dividends from that company. It's just like buying a share in a company, but rather than buying a single company (say, Qantas) and having your investment fluctuate based on their successes (how many flights were made this month? how many planes fell out the sky?) you are buying a very large handful of companies. 

This means that if one company tanks terribly your investment doesn't take a big hit. If one company suddenly triples in value, you only see a fraction of that - because while you own part of that company, you also own a couple of hundred others.

While it sounds dull, it means you can't really screw it up. Investing in individual companies takes hours of research, and you never know what deals are being made on the golf course. You might think you have all the information to know that your speculative mining company is about to hit it big, but their competitor might move in and sabotage their equipment.

If this happened and you owned the little guy, your investment would tank. If you owned an index fund, you might own a little part of the little guy, but you'd own a big part of the big guy. You're investment moves in lockstep with the overall market, but isn't affected by booms and bust like the above scenario. It might be boring, but it's safe. A historic average 7% p/a after inflation kind of safe.

Low fees

Here's the biggest thing. When I was 18 and tried to buy property a broker told me I didn't have enough money. He then tried to sign me up for a managed fund. Like investment funds, managed funds own lots of companies, and you buy a piece of that portfolio. Unlike index funds, managed funds are trying to win!

An index fund simply buys the biggest companies on the market and holds them in proportions that match the market. That means that the Vanguard Australian Shares fund holds large amounts of Westpac, BHP, Wesfarmers and all those other big guys. Rather than trying to guess the winners, they just stick to what the market is telling them.

Managed funds try to beat the market by buying low, selling high and picking out those stocks that are going to boom. That means they spend hours trading stocks, researching, planning and monitoring. Sounds great, but historically most funds don't outperform the market. They might have a good year or two, but they don't run away with the trophy.

What makes all the difference is the fees. This fund was going to charge me 3.5% fees (from memory, it was a while ago.) If stock market has a historic average return of 7% then they would need to return 11.5% to break even after fees. I can tell you right now they weren't going to be able to pull this off. They were boasting 8 and 9% returns.

On the other hand, Vanguard fees for owning a slice of the ASX are a teeny weeny 0.75% per annum. If you're holding more than $100,000 then the fees drop down to 0.35%. They also don't charge fixed brokerage fees per transaction, they instead work on a buy-sell spread percentage. This sounds complicated but it simply means when you buy into the fund you pay 0.1% more than the current value, and when you sell you receive 0.1% less. It looks something like this:

Purchase 100 Units:
Unit Value: $2.0654
Purchase Fees: $0.20654

After one year
Unit Value: $2.209978
Holding Fees: $0.01657
Investment Value: $220.98123

Sell 100 Units:
Unit Value: $2.209978
Sale Fees: $0.2209978
Money in your pocket$220.7768 (6.7% return after one year)

The teeny tiny fees are so small it's barely worth noting. There are fees, and you are paying a little bit, but honestly you'll be paying fees wherever you go. Having small fees making a massive difference in you investment over time.

Tiny disclaimer - when you invest you don't have to do this maths, you can throw $100 at a time at Vanguard and they sort out how much disappears to fees, and how much is invested. You'll never have to transfer them 74 cents to round out a purchase. It was just easier to demonstrate the maths the way I have :)

Cons: Big fat buy in, focus on financials, a terrible website, franking and quarterly distributions

Let's be honest, Vanguard isn't perfect. I work as a Web Developer / User Experience Expert and I just need to get this off my chest.

Vanguard has the ugliest, clumsiest website I have ever struggled with! I do like the product though (You can tweet that, maybe they'll upgrade it)
Mr FIRE is a networks engineer and would like to add that their APIs are terrible to work with, don't follow protocols and make at home data collection tricky (if you're not a nerd, you can ignore that part).

What that means for your Average Joe is that figuring out how to actually sign up is a pain in the behind, and digging around to find out what you're buying into is annoying. It's best to read other sites reviews the get an understanding, rather than trying (and failing) to figure it out from the Vanguard site.

Oh, and once you've opened a Vanguard account, you need to sign up for online banking separately. What a nightmare.

For your convenience:
You're welcome. I've done this before and it was still annoying to find those links.

Big fat buy ins

The thing that put me off Vanguard for a long long time was how much you need to get started. You need to be able to drop $5,000 in one go to open an account. When you're new to investing that is a lot of money, because you should never invest more than you're willing to lose. For investments in ETFs you should be willing to leave it there for years, not months, and $5k is a lot to put away in one hit. But remember for that you are getting a slice of many, many companies - so you know if one of them tanks, your entire investment won't go down the toilet. The only way to lose everything would be if Vanguard went under, and consider the size and history of the company, the odds on that are pretty low.

Once you've paid that first $5,000 you can add to your investment for as little as $100, which is much nicer. And with the ability to make deposits via BPay, you can easily set up a recurring investment - set and forget dollar cost averaging is a massive win in my book.

Focus on financials

One of the risks in investing in an ETF focused on the Australian share market is how much of the banking sector you end up owning. The top ten companies in the Vanguard Australian Shares fund are CommBank, Westpac, ANZ, NAB (the big four banks) then BHP, CSL Limited, Telsta, Wesfarmers (Coles), Woolworth, and Macquarie Bank.

Five of the top ten companies are banks, and they make up 28% of the overall fund. That means that if the banks take a hit, then your portfolio takes a massive hit. Given that the Australian government has just introduced an extra tax on banks, this is a very real concern for me at this time.

My personal solution to this is to also 'shop' outside of Australia - I hold three different Australian based ETFs (this one, another focus on high dividend yields, and another focusing on bonds) I also hold 35% of my Vanguard portfolio as the International Shares Fund. To buy another fund means another $5,000 buy in, but it allows you to diversify even further. 

Franking and quarterly payments

This is one more thing that bugs me about Vanguard. Quarterly payments of dividends mean I'm only seeing payments once every three months, even though I know the underlying shares are paying at random times throughout the year. I understand how this business model works, and it makes sense, but it's... boring. I'd like to see those dividend payments hitting my account more often, just for a little fun.

The more serious concern though is franking credit. Companies pay 30% tax on earnings, and if their dividends are fully franked, it basically means they're pre-taxed. When you declare them on your tax return, what you're saying is "This company paid me $70, and they paid you $30 in tax, so basically I paid $30 in tax". If a dividend isn't franked, you would get $100, but have to pay tax on it. For a more detailed (and really easy to follow) breakdown, check out this post by Pat the Shuffler.

For the sake of this argument though, Franking is good. Very very good.

And with Vanguard, you can't control what kind of Franking you get. If you bought the shares directly you could look at the history of the company, what kind of dividends they pay and what sort of franking credits they offer then make an informed decision based on that. Vanguard might be investing for dummies, but it also takes your decision making power away. You do end up with some franking credits, but it's not as much as you could get if you picked the shares yourself.

Conclusion: Do we buy it?

Heck yes we buy it! Okay, the website is ugly and hard to use, but once you're signed up you can set and forget your investments. Yes we don't have much control over the companies we buy into, but that's also the beauty - most managed funds rarely beat the market, so why waste time trying? Set, forget and move on, come back in a few years to find you're super rich.

The $5,000 start up is a tough pill to swallow, and if you are scared of diving it, you can dip a toe in share market investing with Acorns but the fees structure with Vanguard is far better, and they have decades of history, rather than Acorns few months. 

As an aside - you can also buy the same Vanguard shares without buying them direct from Vanguard. You can buy them in the same way you buy shares through the Australia Securities Exchange. Aussie Firebug put together a great article about how and why he buys that way, including a video where he steps through a purchase. Check out his guide to buying Vanguard, and happy investing!


  1. I'm so happy you got around to posting this guide. Too late for me though, I already invested in Vanguard, and have to agree that their website is the pits.

    My next question then is: why own both Acorns and Vanguard? If you have the cash to start a Vanguard, it has lower fees and you can contribute at will, so why not just use it? I know you have both :)

    Last point: a new Acorn-like product has come into the market 'Clover'. Any thoughts on that yet?

    1. I haven't heard of Clover - I'll have a look at it, but I'm flush with investments at the moment so I doubt I'll open one.

      Like you said, having an Acorns account and a Vanguard account seems a bit counter intuitive because they do very similar things, and Acorns fees are much higher.

      To be honest I haven't thought too deeply into why I have both. If I had $5k in my hands and neither account, I would say Vanguard is a much better choice.

      Acorns appeals to me because of it's interface, the rounding up feature and some of the spend tracking in the app. Plus the ability to make tiny $5 contributions.

      It's not a particularly rational choice to have both, Acorns is like the little brother of Vanguard - younger, more tech savvy, bit more annoying (fees), more fun to hang out with (User interface).

    2. I actually use Pocketbook as my spending tracker, I reopened an Acorns account to check out their spend tracking but just wasn't as happy with it.

      It's so true that Acorns is more fun to hang out with!

    3. I tried pocket book before they could interact with ING - so that didn't work. I remember trying to go back late last year but I couldn't get the transaction categorisations to behave, so moving money to Vanguard was coming up as a bill, and shifting between my own accounts was registering a massive spend and income simultaneously.

      I have my own (excel based) established systems, so I use those

  2. Great to learn that Vanguard funds are available to Australian investors-- I live a few miles away from their headquarters. I also love the fact that you're on the Google blogging platform like me.

    1. I feel like we might be the only ones on Blogger! Wordpress seems to be where it's at, and it's got heaps of support from the Dev community - hundreds of plug ins exist for WP but not so much for Blogger

    2. Hi LadyFire.. Sorry if this is off-topic. Just stopping by to let you know that I completed my migration to a self-hosted Wordpress.. I didn't know that I could stay at Blogger and just change the domain name. :)

  3. Hi there, I came across your blog a couple of days ago and have already read almost every post! Great to read about another female pursuing FIRE in Australia :). I've been trying to compare a company I came across last year called stockspot and vanguard, and not sure which is better in terms of performance and fees. Not sure if you've heard of stockspot? If love to hear your thoughts if you have any. Cheers.

    1. I haven't actually heard of Stockspot - but I did a quick bit of digging and found what I expected...

      Stockspot purchases ETFs and rolls them into it's own portfolios. e.g. They buy the vanguard Aus Shares etf (fees 0.14% p/a) but then tag their own fees on top ($6.60 a month for accounts under $10,000)

      Basically you pay two rounds of fees. While they offer some extras (e.g. auto-rebalancing and nice Tax setups) I don't know if that would balance out the fees.

    2. Thanks!! That's really helpful. How about if you were to have over $10,000 invested? Would that make a difference?

    3. The fees change to a percentage base after $10k, but you're still paying the underlying ETFs fees, plus Stockspots fees. Without digging really deep into it I couldn't tell you at what stage paying the fees is worth the services.

  4. Is the reason you use the retail fund over the ETFs (which have lower fees) because of the ability to continually trickle in funds without having to use a broker? I'm new to investing and want to buy index funds and continue to top them up (set and forget). Trying to work out if ETFs or retail is best for me.

    1. Exactly - on $5,000 the management fee difference is about $40 a year. But a single transaction through CommSec has brokerage fees of $30. Because I have bought directly through the Retail fund I can pour money in whenever I want without paying the brokerage fee :)

    2. Is your long term plan to leave it in the retail fund in the future when your balance is much higher?

    3. That is a wonderful question :) I should answer it some time.

      I'd love to say I've thought about it, but I honestly haven't


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