Last month in A Peek Under The Hood of SMI’s Just-the-Basics Strategy, we discussed how this indexing strategy is designed to be the ultimate in simplicity. It uses only three stock funds (plus one bond fund if your asset allocation calls for it) in an attempt to match the market’s returns.
JtB can be set up in a matter of minutes and requires attention once a year for a quick portfolio re-allocation. Add in the fact that the type of index funds used by JtB are staples in most company 401(k) and other retirement plans and it’s clear why JtB is a strategy with broad appeal.
SMI has always used Vanguard mutual funds or ETFs as the vehicles within JtB. In the early days, Vanguard’s advantage in the index fund arena was significant, as their funds tended to be cheaper as well as better performers (they tended to track their indexes more closely than the index funds of other companies).
But over the past 20 years, other companies have closed the gap in terms of their index offerings. Price wars have driven expense ratios on all of the top index funds to incredibly low levels, with many now costing only 0.1% or so per year. And because indexing isn’t particularly difficult to implement, it’s no surprise that the industry has largely reached the point where most index funds that follow the same index are largely indistinguishable from each other.
Which Funds to Use
So while it used to make sense to pay a small transaction fee to access Vanguard’s funds when investing in JtB from another broker, that is not necessarily true anymore. In most cases, an investor can employ the index funds or ETFs offered by a particular brokerage firm with no transaction fees or commissions. This can lead to substantial savings compared with paying transaction fees or ETF commissions in order to use Vanguard’s funds.
Table 1 on the right shows the alternative funds at Fidelity and Schwab that can be used for each element of JtB. We’ve included the traditional index-fund tickers for each of these, despite the fact that some also are offered as ETFs. (We did this because not all of them are available as ETFs and we didn’t want to confuse anyone by mixing the two types.)
Whether to use traditional index funds or ETFs is really a matter of preference, largely dictated by your specific situation. We switched to ETFs in JtB several years ago to more easily accommodate newer investors and those investing small amounts on a regular basis. Some traditional index funds have minimum purchase requirements that can be avoided by using ETFs. But if you can meet the minimums and the traditional index fund is available with no transaction fees at your broker, you may find it more convenient to use than the corresponding ETF.
One significant advantage is the traditional fund will transact in fractional shares, whereas with an ETF you can only buy full shares. An example: If you have $75/month to invest in a given fund, the entire $75 immediately goes to work in the traditional mutual-fund class each month. With the ETF, on the other hand, you can only buy as many full shares as the share price allows. So if the price per share is $30.25, you’d only be able to put $60.50 to work that month, with the rest idle in cash.
Comparing JtB at Fidelity & Schwab
Table 2 below shows the results over the past five years (2011-2015) of using the fund replacements suggested in Table 1. In some cases, such as with large-stock funds, the results of using the Fidelity or Schwab alternatives are indistinguishable from the Vanguard fund. That makes sense, given that all three use an S&P 500 index fund for that component.
For other components, the results differ. Schwab’s small-stock performance has been a bit lower during the past five years as a result of it tracking a different index (Russell 2000) than the Vanguard and Fidelity options. Likewise, Vanguard hasn’t performed as well in the foreign stock segment for the same reason — it has tracked a different foreign index while Fidelity and Schwab have both tracked the popular EAFE index.
These small differences aside, the two right-most columns of Table 2 make clear that the three companies’ performance has been very close. Whether the portfolio was invested in only the three stock funds, or was further diversified by including the bond component, there hasn’t been any disadvantage to using Fidelity or Schwab index funds rather than Vanguard’s.
While Vanguard likely always will be considered as the leader in indexing due to its pioneering role in the indexing revolution, the numbers say that its top competitors have caught up. As such, any of these three companies should do a fine job for indexers. Minimizing fees and commissions should take priority at this point over using a particular brand of index fund.