Vanguard made another announcement that effective today (10/6), the minimum amount required to qualify for Admiral Shares has been reduced to $10,000 for most of their index funds and $50,000 for actively-managed funds, significantly reduced from the previous $100,000 minimum.

Admirals shares are a separate share class of 52 mutual funds in addition to the standard Investor shares. While owning the same underlying investments, they also take advantage of the cost savings of big accounts and thus have lower annual expense ratios. According to their press release, the lowered requirements means that nearly half of all Vanguard clients can take advantage of at least one of these Admiral funds.

Here is a chart comparing Investor vs. Admiral shares costs for three major funds, along with the overall average across for all similar funds:

Here’s another comparison chart of the same broad funds with similar competitors from Fidelity and Schwab. Note that there are some differences in actual fund holdings, especially in the international funds (click to enlarge with more details):

Here’s a list of excluded index funds:

The minimum amount to qualify for Admiral Shares will remain at $100,000 for the following sector index funds: Consumer Discretionary Index Fund, Consumer Staples Index Fund, Energy Index Fund, Financials Index Fund, Health Care Index Fund, Industrials Index Fund, Information Technology Index Fund, Materials Index Fund, Telecommunication Services Index Fund, and Utilities Index Fund, and for the following tax-managed funds: Tax-Managed Capital Appreciation Fund, and Tax-Managed Growth and Income Fund.

I’m probably going to switch to the Admiral Shares of Vanguard Total International Stock (VGTSX, ER 0.20%) when it comes out, away from the Vanguard FTSE All-World ex-US ETF (VEU , ER 0.25%) which I just converted to. Their holdings are now pretty close. While I don’t mind ETFs that much, they are a bit more work because I like to make a limit order during stock market hours in order to get a proper fill. (I don’t like market orders in case there is another flash crash or similar.) If it’s both cheaper and easier, I gotta go for it.

This will also keep me from converting some of my other mutual funds to ETFs, as the expense difference will either be gone or significantly minimized. They say that the newly qualified folks will have their funds transferred over – with no tax consequences – automatically over the next few weeks. If you’re impatient like me, you can manually request it as well online. Just log into your account at Vanguard and look for the “Convert to Admiral Shares” link. It’s always nice to save some money without doing anything at all.

(Click to enlarge.)

Using the SPDR S&P 500 ETF to represent the S&P 500 stock market since the ETF inception in 1993, the chart above shows the effect of:

• Blue: Holding the entire time. “Buy & Hold”
• Red: Missing the 10 best days only.
• Yellow: Missing the 10 worst days only.
• Green: Missing both the 10 worst days and the 10 best days.

I found this via TheBigPicture, but disagree with the idea that you should try to find out how to miss the 10 worst days avoid the worst days in general. [Edit: See comments for more.] I see no evidence at all that anyone has the ability to predict/avoid the best or worst days ahead of time.

I also don’t agree with the idea that this supports Buy & Hold because you don’t want to miss the 10 best days. Again, if you miss the 10 best, you’re likely to be missing the 10 worst. It works both ways.

The fact that you end up with more money by missing the 10 worst days and less money by missing the 10 best days simply gets a “duh” reaction from me. The bigger divergence recently just reaffirms that prices have been a lot more volatile in the last couple of years.

Instead, the focus should be on that fact that if you take out both the 10 worst days and the 10 best days, you’ll basically do just as fine as buy & hold. Stock market investing is chaotic and tough on the stomach if you watch all the swings. If you take out the swings, you still get the same results! But you can’t in reality take out the swings, so the best thing is to try and ignore them.

I don’t want to spend my life competing against Wall Street whiz kids and supercomputer trading algorithms, so I just invest passively with rock-bottom costs. Work on your career or build a business… put your energy into something in which you have more control.

After the Bogle/Hennessy squabble (here’s the latest), I’ve been digging for more details about mutual fund “supermarkets” where you can buy funds from various managers all with no transaction fee (NTF)… but at a cost. Charles Schwab introduced the concept first in the 1980s. Today, the Big 3 of fund supermarkets are:

• Charles Schwab with 2,000+ NTF funds,
• Fidelity Investments with 1,400+ NTF funds, and
• TD Amertrade with 1,600+ NTF funds

How They Work

Each of these brokers currently charge fund companies 0.40% annually of their fund assets owned through their specific NTF network. So, if a mutual fund XXXXX had $200 million of assets total but only $100 million was through Schwab, they’d have to pay 0.4% of $100m ($400k) a year to Schwab. The fund has to then pass this cost onto investors. However, the annual expense ratio charged to fund investors has to be the same for everyone, no matter where they hold the fund. Therefore, the investors that own the fund through cheaper or more direct means are effectively subsidizing the NTF investors.

Result: Although they are cheaper to buy and sell, NTF funds tend to be more expensive when you look at their annual expense ratios.

TD Ameritrade raised their fee from 0.35% to 0.40% in April 2010 to match the other two, according to this InvestmentNews article. There is speculation now if this means Fidelity and Schwab may raise their rates again as well. Part of this is due to the fact that after the recent financial crisis there is even less competition, due to closures and mergers. (TD Ameritrade itself is a result of a merger of TD Waterhouse and Ameritrade .)

From this Kiplinger’s article, NTF funds can also hurt your net performance in other ways:

NTF funds typically receive a tidal wave of money when performance is red-hot. The money flows out just as rapidly when returns cool. That swift ebb and flow of dollars hurts a fund’s long-term returns because it forces managers to buy and sell securities at times when they may be better off doing the opposite. In-flows and out-flows are usually much less volatile for funds that are outside NTF networks.

The Convenience Factor

If you’re a small fund company, it’s probably a lot of work to sell directly to shareholders, and also you lack the marketing might of the big brokers. From a investor point-of-view, beyond avoiding any transaction fees, we also love convenience. From this RIABiz article:

Schwab and its rivals have gotten a stranglehold on the distribution of mutual funds because they are in the best position to provide the convenience of one-stop shopping and one-statement viewing that no individual mutual fund company ever could.

“It is true that investors can go direct to many of the larger fund families, but they give up a consolidated view of their accounts when they do that,” Ellis says. “We know that clients value that single report that shows all their holdings.”

If You Don’t Pay, You Can’t Be A Top Pick

Each of the brokers has their own “preferred” set of funds that they promote to their customers. Well, you can’t be one of these funds unless you pay the money to be in their NTF platform. Check out Fund Picks from Fidelity, OneSource Select from Schwab, and the Premier List from TD Ameritrade.

Yup, they are “specially screened” alright… and the first screen is if the check cleared… Pay to play.

Do Huge Funds Get Special Discounts?

What about the big boys? Are these fees set in stone or is their a discount for funds with huge assets? Apparently, TD Ameritrade is much more flexible than the others. Perhaps that has helped them grow so fast. From the same InvestmentNews article:

TD Ameritrade is negotiating with fund companies that have low expense ratios and can’t afford the new fee, said one fund company official familiar with the situation, who asked not to be identified. Schwab and Fidelity are not as flexible, the official said.

More proof of this is that T. Rowe Price is now a NTF fund at TD Ameritrade. From the MutualFundWire article Did TD Give T. Rowe a Deal?:

In the past, T. Rowe Price has been reticent to join the NTF platforms, preferring to have shareholders who purchase shares through the marts to pay the transaction fee thereby keeping shareholders who buy directly from subsidizing the sales. T. Rowe Price’s brand is popular with advisors, which may give it a leg up in negotiations with the mutual fund supermarkets, say industry insiders.

A source familiar with the situation said T. Rowe Price is paying “significantly less than 40 bps” TD Ameritrade has been charging other mutual fund firms since early this year when it raised its fee from 35 bps. Just how much less than 40 bps the fund firm is paying could not be learned.

T. Rowe Price is known for their relatively low fees on their actively-managed mutual funds, which combined with their good past performance has created a very strong following of investors and financial advisors. I’m not sure if I would see this as a good or bad thing. If they can increase asset size without hurting performance, then in theory TRP can maintain their low costs for all investors. I guess we’ll see.

Fund Families Fight Back?

As fees keep rising, an analyst from the RIABiz article mentioned above thinks small funds may band together to revolt:

“As fees increase and the platforms capture more of the value stream, I would not be surprised to see smaller mutual fund families, faced with extinction, combining into a sort of ‘open architecture fund warehouse,’ and pull their diminished fund sales from the platforms,” he says. “A fund co-op could undercut Fidelity, Schwab and TD Ameritrade while still providing a single report.”

I think this would be awesome, and relatively easy to set up in this digital age. Good idea for a start-up?

Vote With Your Money

It’s interesting to see how such funds are distributed and promoted behind the scenes, but in the end it is up to us investors to vote with our money. If you think it’s worth it to buy NTF funds through one of these brokers, then you can continue doing so. But look around, there may be similar funds out there that are cheaper to own. Look at fund companies like Vanguard, PIMCO, and Dodge & Cox that don’t do NTF hardly anywhere. In addition, smaller fund supermarkets like E-Trade may charge less and thus offer a more options.

In a recent Wall Street Journal Op-Ed article by Vanguard founder Jack Bogle, he reaffirmed studies like the one from Morningstar showing that one of the strongest predictors of mutual fund performance is how low their annual expense ratios are. In addition, he shared data that fees on actively-managed funds continue to rise despite increasing asset sizes:

Conclusion: The huge economies of scale available in managing other people’s money have largely been arrogated by fund managers to their own benefit rather than to the benefit of fund shareholders.

In a letter to the Editor, Neil Hennessy, president and chief executive of fund manager Hennessy Advisors Inc. shot back, listing his own reasons for keeping his fund fees north of 1% (100 basis points) annually.

For one of our typical funds, federal and state registration fees have increased 44%, legal fees have increased 73%, and audit fees have increased 30%. […] Also, while no-transaction fee platforms didn’t exist in the 1960s, today funds pay as much as 40 basis points to be on the platforms offered by the likes of The Charles Schwab Corp. and Fidelity Investments.

According to this Investment News article, other mutual fund managers also feel this way.

His grievances are shared by many in the fund industry, said Don Phillips, a managing director at Morningstar.

“I think a lot of people would be afraid to do what Neil did and that is to out the distributors,” he said. “The asset managers are taking all the blame for high fund expenses, while the distributors are completely off the radar.”

I thought this was an interesting debate. I had no idea it cost that much for smaller mutual funds to get the accessibility of being part of a mutual fund “supermarket” like Schwab or Fidelity. However, that cost does allow investors to buy the funds with no transaction fee (NTF) at these places, which no doubt encourages more activity. In the long run though, 40 basis points is a huge ongoing drag. Here is an old 2004 Forbes article I found on fund supermarkets that also confirms the 35-40 basis point number.

I logged into Fidelity and found that all 10 non-institutional Hennessy retail funds were on the Fidelity NTF list. However, their expense ratios were also in the 1.30% to 1.70% range – well above average even for active funds. Hennessy isn’t exactly doing all they can to save money for the investor.

It would be nice if smaller mutual funds had a more open marketplace to distribute themselves, since it would seem a huge percent of their cost is just marketing. Of course, that’s also true for a lot of other things we buy, from breakfast cereal to basketball shoes. At the very least, an investor should always try to buy direct from the fund provider whenever possible.

In the end, I’m happy that I can buy most of my mutual funds “wholesale” from Vanguard with their at-cost philosophy, along with some “loss-leader” index funds from Fidelity. Shop smart! 🙂

Hat tip to Barry Barnitz of Bogleheads.