What’s in a fund’s benchmark? Apparently a lot.

It’s been several years in the making but Vanguard is changing the benchmarks it uses for its index funds. I didn’t think much about the news but it turns out it was a cost saving movie. When mutual fund companies, like Vanguard, use a benchmark for its funds, it has to pay that benchmark a fee. The licensing fee is not insignificant and can amount to close to 0.01% tacked onto the expense ratio of a fund.

If 0.01% seems like chump change, it is and it isn’t. For a low cost mutual fund, 0.01% is a big chunk when the fund itself is only charging around 0.15%. 0.01% is nothing for an actively managed fund that has an expense ratio north of 1%!

One fund that I invest in, the Vanguard Total Stock Market Index has an expense ratio of 0.18% (the Admiral Shares sport a 0.06% expense ratio), will be changing its benchmark and hopefully that means a svelter expense ratio.

As I’ve always believed, it’s difficult to make a meaningful impact on the performance of your portfolio (index is best!) so it’s best to control what you can – how much you pay to invest. I’m glad to see that Vanguard is continuing their commitment to lower costs, I wonder if changing benchmarks will have any impact on performance.

When I first started investing, I put a lot of stock into these broker rankings because I didn’t have any of my own experiences to draw upon. I didn’t know how I would use a broker, what features were important to me, and whether or not a deficiency really matter. Price was the number one factor, as is the case for a lot of investors.

Then, as I started to invest more and more, I realized that price wasn’t everything because I didn’t make a lot of trades. While it seems silly to pay $20 a trade when there are brokers offering trades for less than $5, it may make sense if the broker offers other features that you value. Nowadays, the differences in prices is much lower anyway and so the “other” factors, like customer service, fund offerings, and banking services become more important to me.

You have to review these rankings through your own rubric. There isn’t really a #1 broker for everyone, but there will be a #1 for you.

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For as long as I’ve been reading and writing about personal finance, index funds have been popular because they offer a low cost way for investors to get diversified into the market. I’ve long been a customer of Vanguard and index funds have always been popular with its founder, John Bogle.

Lately, index funds and index ETFs have exploded in popularity because people are starting to buy into low cost investing as the best way forward. Active funds remain popular but index funds usually win out, after expenses are considered.

So when you start looking at index funds, does it really matter if you invest with one broker or another? Surprisingly there is a little variation with mutual fund companies and it really pays to do your homework.

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Every year Kiplinger’s magazine puts out a survey of the best online brokers. Every year, I take a look at the list because I’m curious how the different brokers stack up. I’d like to know if anyone has made any big changes or improvements to their service, it might change my mind about who I do business with.

Usually the lists don’t change all that much. As you scan this year’s list, you’ll see the same ones near the top, the same ones near the middle, and the same ones near the end. The meat is in the article detailing the different categories (like commissions and fees, investment choices, etc.) because it adds a little color to an otherwise robotic list.

One important thing to remember as you peruse this list: the best online broker is the broker that satisfies all of your requirements. All the bells and whistles in the world don’t matter if they don’t offer exactly what you need. With so many brokers, many of which are inexpensive, you should be able to find your best broker, online or offline, if you’re diligent.

Let’s get to the list…

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The Power of Passive Investing by Richard Ferri explains why investing is so much easier when you do it passively through index investing. If this sounds like John C. Bogle, founder of Vanguard, then you won’t be surprised to learn that he wrote the foreword to this book! (or that Ferri was a co-author of The Bogleheads’ Guide to Retirement Planning)

There’s one quote in the book that I think sums up why passive investing is a good idea: “Investment greats such as Warren Buffett, Peter Lynch, and David Swensen are all outspoken advocates for passive investing. In addition, the U.S. government’s Thrift Savings Plan (TSP) for federal employees has only passive investment options available for participants.” When you couple that with the statistics and research that Ferri has put into the book, it’s a combination of facts that become very difficult to refute if you want to advocate active investing.
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If you’re a long time investor with Vanguard, chances are you’ve taken a look at their “Hypothetical growth of $10,000″ chart included with each of their mutual funds. If you’re like me, chances are you take a peek but never spend much time digging much deeper. I tend to focus on expense ratio, average annual performance versus a benchmark, risk potential, and some other metrics like SEC yield, portfolio composition and characteristics.

Reader Javier looks a little more closely and found something that seemed, at least initially, distressing. He took a peek at Vanguard’s Short Term Treasury Fund (VFISX) and found the nice upward trending chart a little at odds with the one at Yahoo. At first glance, it looks significantly different (stretch it out to start in 2000).

So he emailed Vanguard to ask what was up… and this is their reply:
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After writing this morning’s Betterment review and reading about their rebalancing feature, I started thinking about rebalancing. Betterment rebalances your portfolio after each quarter and if your actuals deviate from your allocation by more than 5%. In other words, they rebalance on a schedule and when the deviation exceeds a certain level (5%). When you read about rebalancing and when you should do it, many places often just point to a calendar date – rebalance every quarter, every six months, or once a year.

What is Rebalancing?

Rebalancing is the act of adjusting your actual investment allocation so that it meets you desired investment allocation. If you want to be 80% stocks and 20% bonds, you need to rebalance your investments periodically since both will likely perform differently over time. How often and when you rebalance is a matter of debate but as is the case with any type of investing (or gambling), it’s about the odds, your plan, and sticking with the plan as long as it’s worth sticking to!

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Annuities often get a bad reputation because they can, at times, be very complicated and filled with fees. Like many financial products, they aren’t inherently bad for you but a few bad actors make the whole industry look a little shadier that it actually is. The most basic of annuities, known as immediate life annuities or income annuities, work like pensions, if you could buy into a pension. You pay an up front lump sum and receive regular payments for as long as you live. The bad part about annuities comes when you start getting more complicated, like variants of variable annuities, and throw in expensive fees.

I was a little surprised that Vanguard, my favorite mutual fund company, opened up Annuity Access, an annuity “marketplace.” They offer variable and fixed annuities with the promise that their fees will be as low as you expect from any Vanguard product. I haven’t done a lot of research into annuities but it seems as though Vanguard’s variable annuities are fairly cheap. There are no sales charges, no surrender charges, and their variable annuity’s annual costs are 75% less than the industry average, based on Morningstar’s July 2010 figures. Vanguard’s annual fees are 0.62% versus the average of 2.40%. (I only did a perfunctory look at the fees, if you’re planning on using this service I’d read into the fee schedule a little more just to be sure)
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