3 Wealth-Sapping Myths About The Market's Best-Buy Tracker

Published in Investing on 9 November 2011

The Vanguard tracker offers rock-bottom charges -- but confusion abounds.

Here at the Fool, we're big fans of index trackers. But for years, the tracker products that are most favoured by our American colleagues -- low-cost trackers from Vanguard -- weren't available to us here in the UK.

In short, Vanguard -- founded by investing legend John Bogle in 1975 -- stuck to its American roots, where today it is an industry giant, with total assets of nearly $2 trillion.

But that all changed in 2009, when Vanguard announced it was setting up in here in the UK. True to form, it stormed into the UK market offering index trackers with a Total Expense Ratio (TER) of just 0.15% -- a cost equivalent to a tenth of some of those on the market, and less than half that charged by the firm's nearest competitor.

Stealth marketing

No wonder, then, that two years later, Vanguard's UK operation was able to point to having some £2 billion in funds under management -- a whopping success in anyone's book. And some of that money, I'm happy to say, belongs to yours truly.

That said, Vanguard's approach to the UK market has been somewhat low-key. Initially, for instance, it marketed itself chiefly to financial advisers seeking index trackers for their clients -- and this market is still an important one.

Barriers to wealth

As a result, several myths have arisen -- myths that often crop up when I and others write about Vanguard products here on the Fool.

Last week's article on the cheapest index trackers, for instance, saw a couple of old chestnuts aired again in readers' comments, even though we writers routinely try to de-bunk them.

And because these myths serve to act as a barrier to one of the best investing options out there, it's worth having a crack at dispelling them once and for all.

Here, then, is the real low-down on Vanguard trackers.

Myth 1: You need to invest £100,000

No you don't, quite simply. £100,000 is the minimum amount required if you want to hand over your dosh to Vanguard directly.

As Vanguard's Peter Robertson pointed out when I spoke to him shortly after the launch, setting up a retail platform is an expensive proposition. Consequently, the business prefers to go through intermediaries to reach retail investors.

If you have £100,000, great, then Vanguard will take your money. But for any lesser amount, you'll need to go to a fund platform.

At which point, we encounter myth 2.

Myth 2: Fund platforms don't carry Vanguard products

Oh yes they do -- but perhaps not the fund platforms that many readers routinely use.

Because of its firm policy of not paying commission to fund platforms, most platforms have thus far denied Vanguard access to their clients.

You'll look for Vanguard's low-cost trackers in vain, for instance, on platforms such as those of Hargreaves Lansdown (LSE: HL) and Fidelity, even though these firms are normally those where you would expect to find investor-friendly retail products.

On the Hargreaves Lansdown platform, for instance, the cheapest trackers on offer are those from HSBC (LSE: HSBA), which have a TER of 0.27%. That's still a cracking good buy, of course, but not quite at Vanguard rock-bottom rates.

On Fidelity's FundsNetwork, meanwhile, the cheapest is Fidelity's own Fidelity Moneybuilder UK Index tracker, on a TER of 0.3%. Again, good value, and cheaper than most on the market, but not as cheap as Vanguard.

In fact, at the moment -- because, as stated, Vanguard doesn't pay commission -- just three platforms carry Vanguard's products: Alliance Trust Savings, Sippdeal and Bestinvest.

Which is best? That depends on your circumstances, how much you want to invest, and how often. Simply put, you'll need to carefully study the charging structures -- although blogger Monevator has done some of the digging for you.

Myth 3: Vanguard charges an upfront fee on UK trackers

Oh no it doesn't -- although it might look that way.

As I've explained before -- and again, in article comments -- the 0.5% that Vanguard levies on initial purchases is a tax: Stamp Duty Reserve Tax (SDRT), imposed by Her Majesty's Revenue and Customs (HMRC). And the money that Vanguard collects from you is duly handed over to HMRC, not retained.

SDRT is payable whenever UK stocks are bought, and whenever the shares of a fund investing in UK stocks are redeemed and subsequently re‑issued. On the individual share purchases that we make as investors we pay it, and trackers are no different.

What is different about what Vanguard is doing is that every other provider ‘absorbs' SDRT, including it within their tracking error -- and in so doing, penalises long-term buy-and-hold investors at the expense of short-term tracker traders.

In short, when you buy a Vanguard UK tracker intending to hold for the long-term, you pay SDRT -- but only once, at the time of purchase. Thereafter, you get a rock-bottom TER, and an industry-beating tracking error.

On the flipside, precisely because it makes the SDRT charge explicit, Vanguard trackers aren't for short-term holders. A 0.5% SDRT charge and a 0.15% TER add up to 0.65% -- more than twice HSBC's 0.25% and Fidelity's 0.3%.

Foolish bottom line

So there: three Vanguard tracker myths debunked. More questions? There's further information on the Vanguard website, or on our new Vanguard discussion board. Or ask in the box below!

More from Malcolm Wheatley:

> Feeling flush? Enjoy The Motley Fool's special wealth report -- How To Stay Rich -- it's free!

> Malcolm owns tracker products from Vanguard and HSBC, and holds investments with Hargreaves Lansdown and Alliance Trust Savings.

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Comments

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MunroMan 09 Nov 2011 , 9:50am

You still need to pay platform charges for sub £100k investments.

Some trackers can be bought directly without going through a platform. That means with no initial commission, no dilution levy to cover stamp and no other charges on top of the amc these might be cheaper alternatives fior the smaller investor.

Hannibalis 09 Nov 2011 , 2:37pm

A nice bit of advertising for Vanguard!

Index trackers have their place - for people who do not want to think
about investing. For people who do not mind seeing the market go up and then down and then up and down again - and have no control. A bit like when my wife drives the car.


On the other hand some investors like to have their own strategy.

ponym 10 Nov 2011 , 1:03am

Malcolm

HSBC have told me that they now only sell their trackers via IFAs.
Is this true? and if so how many others do the same?

ajooba 10 Nov 2011 , 9:38am

LordEssex : not sure what you mean by 'platform charges'. You mean 'wrap platform' ? If you go thru Alliance Trust, the only charge is £12.50 per trade. If you choose to buy regularly (say 3 times a year), then the charge is £5.00 per fund. Dividend re-investment charge is supposedly £5.00 per £100 worth of dividends reinvested, but I suppose you could go for "accumulation" units instead of "income" units.

Malcolm : The problem with the £100K limit is that : the £100K limit is *per fund*. So, even if I have £100K to spare, I could go directly to Vanguard but can invest in only 1 fund. Thats not exactly a diversified portfolio, now, is it ? Vanguard offers 'balanced fund's, i.e LifeStrategy funds, so it is tempting to put the £100K in LifeStrategy™ 60% Equity Fund(60% stocks, 40% bonds), however it may not be tax efficient. For instance, the usual advise (Bogleheads, Tim Hale:Smarter Investing etc) is to hold the bonds in the tax-sheltered part of the portfolio and the stocks in the taxable part of the portfolio. All I am trying to say here is that if you want to go directly to Vanguard to build a diversified portfolio of a few equity funds and bond funds, you would need way more than £100K : a nice multiple of £100K would help.

I did quite a bit of research on this a while back. The other problem is that if you go with Vanguard directly, you cannot become a non-UK resident at any point in future. But if you go with Alliance trust, and later you become non-UK resident, they will not let you buy new funds, but you can add to existing funds. But if you go to a wealth manager, these restrictions do not apply. If Vanguard introduces a new fund tomorrow (say, a small-cap-value fund) , but I live in Cayman Islands, I will be allowed to buy that fund in my UK account, even tho I am a non-UK resident because the wealth manager is doing it for me. Lot of silly complicated rules designed for the ultra-wealthy by the ultra-wealthy and their pontificating holier-than-thou cohorts in governments. For the small investor with a global career, life is not exactly easy.

fiftyacorns 10 Nov 2011 , 12:25pm

Most of the big suppliers will offer discounts to members with over £100K that get similar TER's to Vanguard

MDW1954 10 Nov 2011 , 2:47pm

Hello ponym,

I think whoever you spoke to has confused "platforms" with "IFAs" (which also offer platform-based investments, eg via Cofunds).

HL still sell them, anyway!

Malcolm (author)

15551 10 Nov 2011 , 6:11pm

Advertised TERs
Vanguard tracker TER = 0.15%. This does not take into account the SDRT, purchase + selling fee or AMC of £30.

HSBC tracker TER = 0.27%. No SDRT, no purchasing / selling fee, no AMC.

To get Vanguard's 'real' TER to the equivalent/less than HSBC's you would need to hold approx £25,000 + worth of units (and this doesn't factor in the purchase and selling costs or AMC).
£30 (AMC) is 0.12% of £25,000. + 0.15% (advertised TER) = real TER of 0.27%.
Holding less than £25,000 worth of units means that you the TER will be higher than 0.27%

I don't currently own any trackers, but the above is worth considering.

unhappymondays 11 Nov 2011 , 2:53pm

I have a Sippdeal account and tried to get a Vanguard fund through them earlier in the year - impossible at the time, even though I had contacted Vanguard directly (got told their minimum was £100,000!) and then spoke to Sippdeal who said that yes, in theory I could get Vanguard funds through them - but not in practice! Needless to say, I didn't pursue this any further, although it could be just another of Sippdeal's 'teething' problems they get when introducing new services, so I may give it another go now.

DAMM01 11 Nov 2011 , 3:34pm

I find the info about Vanguard to be confusing.

Are extra costs involved when using a broker rather buying direct from the fund provider?

What are the comparitive total costs for purchasing and operating £5K worth of:
M & G Index UK All Share Accumulation Class A
Fidelity Index UK All Share Money Builder
Vanguard Index UK All Share

When purchasing from one of the three (above) providers, which is the most financially prudent:
To bulk buy £20K of above funds
or
To drip feed £20K puchasing the funds?

15551 11 Nov 2011 , 6:05pm

DAMM,

"What are the comparitive total costs for purchasing and operating £5K worth of:
M & G Index UK All Share Accumulation Class A
Fidelity Index UK All Share Money Builder
Vanguard Index UK All Share"

This is a difficult question to answer as there are many permutations. I haven't researched Fidelity or M&G so I cannot really help there. With regards to Vanguard it depends on which platform you choose. Let's assume that you decide to open an account through Alliance and purchase £5,000 worth of Vanguard units through Alliance's platform.

£5,000 initial investment
less £12.50 dealing fee for buying
less £25 SDRT
leaves £4,962.50
less £7.44 Vanguard TER (0.15% of £4,962.50)
less £30 annual management charge. Alliance Trust
leaves £4,925
less £12.50 dealing fee for selling

leaves £4,912

If your initial investment is £5,000 and you have just purchased the fund you'll be left with £4,962.50. Now, the total real TER on this amount would be 0.75% (Vanguard's charge + Alliance's annual management charge).

Real TER = 0.75%

I hope that helps

percy59 11 Nov 2011 , 8:17pm

hello ponym,
youcan buy hsbc trackers direct print of an application form from there web site and post it in.

eglesb 12 Nov 2011 , 3:22pm

Surely if alliance have to charge 0.5% SDRT (tax) then HSBC must have too aswell. In which case either:
1) HSBC are being very nice any paying it for you on the basis that they will get their money back eventually through their 0.27% TER (i.e. the tax is included in the annual charge spread across all investors including those who have been long term holders)
or
2) HSBC are deducting the 0.5% tax from the fund itself which will lead to a bigger tracking error.

Which is it?

ajooba 15 Nov 2011 , 8:56am

15551, you seem to imply that the annual TER with Vanguard is 0.75%. That is not correct. The 0.5% SDRT is a one time thing (for every purchase). You dont pay it every year. Not sure how HSBC absorbs it, but maybe that is why their TER is higher than 0.15%. Considering only the TER and SDRT and not the transaction fees, I guess it takes about 4 to 5 years for the Vanguard investor to beat the HSBC investor on cost. Also, does HSBC offer such low cost trackers for various asset classes ? After all, you would need to track domestic stocks, international, some emerging market, bonds etc to build a diversified portfolio. Can you build a complete tracker based "lazy portfolio" using HSBC ? Would be nice to know. I am curious.

Knowing Vanguard from the US, I suspect the tracking error would be minimal with Vanguard.

Transaction fees are another thing : This is not charged by Vanguard. If we were drip feeding every month, maybe better to go with bestinvest.co.uk as monevator suggested.

15551 15 Nov 2011 , 5:12pm

Ajooba,
That's incorrect, I'm not implying the 0.5% one-off SDRT is part of the TER. If you re-read my previous post and breakdown you will see that.

I arrive at a TER of 0.75% by adding together Vanguard's annual fee of 0.15% and Alliance's annual management charge of £30.

For simplicity let's assume you have £5,000 (I won't deduct SDRT or dealing commission for this example).
£5,000
Vanguard's annual fee of 0.15%. so £7.50
Alliance's annual management charge of £30
Total annual fees are £37.50
£37.50 is 0.75% of £5,000.
Simples

15551 15 Nov 2011 , 5:15pm

I worked it out earlier:

Less than £25,000 use HSBC
More than £25,000 use Vanguard

ajooba 16 Nov 2011 , 6:49am

15551 : Thanks for your response. Let us take your £5000 example again and consider the costs.
Let us ignore the £30 AMC for the moment (I will come to that subsequently).

Suppose you invest for total of 6 years at least.

with Aliance trust and Vanguard :
=> First year
=> SDRT = 0.5% of 5000 = £25
=> Dealing cost = £12.50
=> Vanguard annual fee = 0.15% of 5000 = £7.5
=> Total First year cost with Vanguard = £45
=> For the next 5 years, the only cost is 0.15% per year. For the sake of example assume fund value is still 5000 each year. 0.15% * 5000 = £7.5. Cost for next 5 years = 5 * 7.5 = £37.5

At the end of 6 years, total cost = £45 (first year) + £37.5 = £82.5

with HSBC, it is a flat 0.27% each year. 0.27% * 5000 = 13.5
Over 6 years, this adds up to 13.5 * 6 = £81

from 7th year, you are winning with Vanguard.

Now, let us come to AMC charges : Looks like the AMC is what is killing me. But I thought that if you wanted to build a diversified portfolio, you would need a basket of funds : UK Allshare Index, Developed World ex-UK allShare index, Emerging markets, UK govt Bond Index, UK index-linked Index and maybe a global REIT (property) index. Except REIT, Vanguard offers all these indexes. As Monevator said, whether you go with bestinvest, alliance etc, there is going to be an AMC charge. However, I just went thru the HSBC website and it looks quite impressive. HSBC trackers are available for almost all of the above indexes at low cost. For the index linked gilts and emerging markets perhaps one could go with iShares in a selftrade account. I dont think there is an AMC charge for selftrade. So perhaps it is possible to build a low cost index-fund portfolio without AMC charges. I already went ahead with Vanguard tho' and paid the £12.5 and the 0.5% so maybe it is too late for me. My total portfolio size is more than £100,000 but I really have to work out and see if Vanguard comes out cheaper. HSBC is starting to look attractive now. Oh well.

Thanks.

15551 16 Nov 2011 , 2:06pm

ajooba,

If you ignore the annual management cost, then yes, Vanguard would be cheaper after the 7th year in the £5,000 example. However, unfortunately annual management costs are a very real expense that have to be factored in.

As you have a portfolio of £100,000 the £30 annual management charge is going to hurt you much much less than the other person who was looking to invest £5,000. So in fact, for you Vanguard may be the better option. If you do some sums you should be able to work it out. HSBC seem to be offering some good products. iShares offer a lot of ETF products.

You can certainly construct a good portfolio without AMCs.

What I find quite frustrating with these products is that they offer these "amazing" rates, but as you scratch beneath the surface all these other hidden costs appear which are a real drag on performance.

Personally I would prefer the simplicity of the HSBC tracker because I pretty much know what I'm getting - no annual management charge, no buying/selling fee etc. I cheked, you can purchase the HSBC tracker through Hargreaves Lansdown and there is no AMC, buying / selling fee etc. Hargreaves Lansdown will charge an AMC on some trackers, but not the HSBC one.

All the best

ajooba 19 Nov 2011 , 12:56pm

15551,

Thanks. hopefully this thread is still active and you can read my reply.

agree with you about hidden charges. It is such a pain. My head hurts doing the comparison to find out which one is the better deal. It is not that easy to compare. You can do hypothetical cost calculations over a few years to see how many years it takes for say, Vanguard to beat HSBC for example, but the problem is that the value of your investments will fluctuate every year, and the percentage TERs or costs are based on the value of your fund, so it is not straightforward to do the comparison. I suspect most of us have fulltime jobs, and with the recession being what it is, we cannot complain too much to our employers and we have to put up with the extra workload and hours resulting in very little spare time to organize personal finances.

I could go an advisor, but it is hard to find good advisors who know about passive investing, and can help with this type of portfolio building and initial portfolio setup. Our pension advisor in the UK company I work for, is clueless about monevator, Tim Hale's book, Bogleheads etc. I wish I could hire Monevator, pay him or her hourly, and help me with the cost comparison, and set up a portfolio. There are advisors who know these things, but these are typically DFA advisors who want to marry you, i.e they want a permanent relationship with you, and will manage your money for a percentage of your assets as yearly fees (around 1%). If you go this route, you also have to pay for a 'wrap platform' such as Transact which is another 0.5% in fees. So, thats 1.5% gone right there. Every year. And then you have the fund TER on top of that. So, I keep going around in circles and I still dont have a decent portfolio set up.

As pointed in the Monevator link above, with Vanguard + Alliance Trust, the AMC is £0 for dealing account, £30 for ISA and a whopping £150 for a SIPP. Typically a DYI investor would have all three, so you are looking at £180 total cost. Plus the dealing fees of course. If I go with HSBC tracker funds + (HL or III platform), is there no AMC for all three types of accounts : i.e dealing, ISA, SIPP ? But even then, for the emerging markets and index-linked gilts, you would have to go to another platform such as L&G, or Selftrade (since HSBC is not offering those funds). I suppose I should look at a complete portfolio, decide the funds for the taxable and tax-sheltered parts and then look at alternatives and compare costs. I am just mentally tired and probably need professional help doing this, as I havent found the time or ability to do it thoroughly.

My other complication is that I may become non-UK-resident in some time but may eventually return to UK. Many companies have issues dealing with non residents. With Alliance Trust, I confirmed that once the portfolio is set up, I can add to it even as a non resident, but cannot add new funds. With L&G, I think it is complete freedom as a non resident. Not sure about HSBC trackers + (HL or III), whether I would have to close my account once I become non resident. So I need to find out this also.

I am back to Square 1 and not sure what to do.

15551 21 Nov 2011 , 6:54pm

ajooba,

News just in, Hargreaves Lansdown is now going to start charging for HSBC trackers. This changes the calculation yet again!

http://www.thisismoney.co.uk/money/investing/article-2064358/Hargreaves-Lansdown-2-monthly-charge-tracker-funds-offers-Vanguard.html

I have done extensive research and it does take a long time to work everything out. I'm not an expert so I wouldn't want to advise you on your position.

Good luck

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