With extremely low fees compared to other fund management companies, yet an extensive customer service network I recently came to wonder: how does Vanguard make money? So I did some research and this is what I found:
Although Vanguard makes some money from mutual fund and ETF fees they essentially operate at cost for all U.S.-based investors. This includes paying salaries, facility upkeep, and R&D among other things. The remaining profits are returned to investors through Vanguard’s funds.
But I wanted to know more! How does Vanguard’s business model actually work? And how exactly are the fees structured in order to achieve maximum efficiency for their funds? Are there any hidden fees you should be aware of?
In the following paragraphs, we’ll take a closer look at their business model and the exact fee structure for most of their funds. I’ll also go over what Vanguard’s annual service fee is and how it can easily be avoided.
Why Vanguard does not need to make money
In order to fully answer the question: how does Vanguard make money, we need to take a closer look at their business model.
Vanguard’s business model is to let their investors profit first. This way, investors who purchase shares in Vanguard’s fund actually become partial owners of that fund. This allows Vanguard to operate at cost in the U.S. and “low-cost” overseas and internationally.
Vanguard’s “at cost” business model
This business model is pretty much in the managed fund space and runs counter-intuitive to common-sense business practice. While other fund management companies may also charge very little or no fees, i.e. Fidelity, investors do not become shareholders by investing in their funds.
Vanguard’s mission statement fully reflects their current business model. Their mission is:
“To take a stand for all investors, to treat them fairly, and to give them the best chance for investment success. “
This mission statement and the thereof resulting business model is one of the main reasons why Vanguard has gained a huge following of loyal investors who trust the company with their entire net worth and investment portfolio.
Running their funds at cost significantly reduces fees paid by investors thus giving them the best chance to succeed. Vanguard is able to follow this business model as they mainly focus on very large index funds (ETFs) which require no management and only very little upkeep.
However, even their mutual fund fees have been reduced to the bare minimum amount required to run the fund. This business model is further unique in that it only applies to all U.S. based products. For overseas and international products Vanguard operates at low cost instead of at cost, yet is still able to undercut the competition by a large margin on fees.
You can read more about my thoughts on Vanguard here.
How Vanguard makes money
Vanguard is one of the fund management companies with the lowest fees out there. However, as they still not maintain their funds and pay employees they do charge small fees on most of their products. These are the fees for the most common Vanguard funds:
Mutual Fund Fees
- Money market funds range in fees from 0.11% for the Federal Money Market fund up to 0.16% for most other taxable and tax-exempt money market funds such as the Prime Money Market fund or the California Municipal Money Market Fund.
- U.S. bond funds have slightly higher fees on average but also a wider range of fees starting at 0.05% for their Total Bond Market Index Admiral Shares (VBTLX) fund up to 0.20% for most of Vanguard’s short-term bond funds and even 0.21% for the intermediate-term government fund GNMA. Vanguard’s core bond fund (VCORX) has the single highest expense ration of 0.25%.
- Balanced funds have the widest range of fees associated with investing as require more upkeep and management. The lowest I could find here was the traditional Balanced Index Admiral Shares (VBIAX) at just a 0.07% expense ratio. However, especially the managed payout or global funds become far more expensive at fees of up to 0.46%. Vanguard’s target date retirement funds fees are somewhere in the middle around 0.13-0.15%.
- U.S. stock funds are among their cheapest mutual funds you can find with fees almost close to the expense ratio of an ETF (Exchange Traded Fund) such as the 500 Index Admiral Shares (VFIAX) fund with fees of just 0.04%. This is unheard of for a mutual fund.
- International bond and stock funds are among the most expensive you could pick. Here you will fees up to 0.93%. This is due to the fact that Vanguard is focused mainly on the U.S. market and their mission is primarily geared to helping U.S. investors.
- U.S. bond ETFs are far less expensive – as all ETFs are – compared to Vanguard’s mutual funds. Here you will not pay more than 0.07% in fees for any fund you choose. The U.S. bond ETF with the lowest expense ratio is the Total Bond Market ETF (BND) with only 0.035% in fees.
- U.S. stock ETFs are among their most well-known products around the world which is mostly due to Vanguard’s extremely low fees. Among those are VTI, VOO, and VIG which you can invest in for just an annual fee of 0.03%. Being able to invest in the entire U.S. stock market or S&P 500 is a huge advantage for Vanguard investors and set them up for successful investing.
- International stock and bond ETFs are just like their mutual fund counterparts among the ETFs with the highest expense ratios. Even though among these you can find low expense funds such as the Total World Bond ETF (BNDW) for only 0.06%. Other ETFs in this category can go as high as 0.27% such as the International High Dividend Yield ETF (VYMI).
- Sector & specialty ETFs are all relatively low-cost at 0.10% in fees.
Keep in mind that overall Vanguard’s fees are among the lowest in the entire industry. I have not found many ETFs that come even close to the low annual expense of a Vanguard fund.
Some of the fees mentioned above might seem high at first, especially for a company that is trying to operate at cost but remember that running an international managed fund will take a lot more manpower and monitoring as well as increasing transaction costs than a domestic fund that simply follows an index.
None of Vanguard’s fees are necessarily hidden but there are some fees you might not expect at first when thinking about investing with them.
Vanguard has “hidden” fees in terms of fees that are not included in the expense ratio of each fund. Vanguard’s annual account service fees are an example of that. Although they are very transparent with every fee they charge ahead of time, it still come as somewhat of a surprise that there are fees associated with simply owning a Vanguard account.
In many cases, the fees can be avoided by either opting for Vanguard’s e-delivery service or by becoming a Voyager, Voyager Select, Flagship, or Flagship Select client; an option that many loyal Vanguard investors may choose.
So here are the annual account fees I found:
- For Nonretirement accounts, Roth, traditional, and SEP-IRAs and UGMAs, UTMAs, and education savings account the following fees apply: $20 for each Vanguard Brokerage account if the balance is less than $10,000. For mutual fund-only accounts, the annual fee is also $20 for each mutual fund if the account does not exceed $10,000.
- SIMPLE IRAs have a fee of $25 for each Vanguard mutual fund in each account.
- 403(b) plans will annually cost you $5 per month per Participant ($60 per year).
- Individual 401(k) & Individual Roth 401(k) plans are associated with an annual fee of $20 for each Vanguard mutual fund in each account.
- The Vanguard 529 Plan has currently no fees listed on their site.
So there you have it! Hidden fees do not really exist but surprising fees certainly do. The good news is though that most of these fees are either waved by Vanguard or can be avoided pretty easily by opting out of certain Vanguard services.
So how does Vanguard make money? As we have seen they pretty much don’t. Vanguard truly was built primarily to serve investors.
This is not only reflected in their mission statement but also in how their fund fees are structured. Giving especially U.S. investors the best chance to successfully invest in the stock market.
Personally, I find the fact that Vanguard basically does not make any money and is so dedicated to serving investors truly inspiring and innovative. I am a huge fan of their ETFs and their low fees and will continue to be a dedicated investor with Vanguard.
So, what do you think? Do you support Vanguard’s business model?