When I was a kid, I had a red Ferrari. 

It was about a foot long, remote controlled, and came with a cool set of pylons for me to practice weaving in and out of.

I loved terrorizing our two cats with it.

Chasing tabbies all day took a toll on its battery consumption—so this was my first real foray into car expenses.  What did I learn?  You get what you pay for.

The red Eveready batteries were cheap and light.  I figured they were a great deal, so I remember buying multiple packs of them.  But the more expensive Duracells, I found out later, lasted a lot longer….and were ultimately a better value.

The problem is that many people carry this “higher price = higher value” mindset into investing.  But as the founder of Vanguard (John Bogle) suggests, in the investment world, you get what you don’t pay for.

One-Stop Shopping

Many investment companies have offered simplified investment solutions:  single funds that combine other funds within them.  They’re usually referred to as “Target Retirement Funds” and the general idea is that you’d choose a fund name that corresponds with the proposed date of your retirement.  For example, if you planned on retiring in 2035, you could buy a Target Retirement 2035 fund.  Within it, are a blend of other funds, and as you get closer to your retirement date, the fund increases its bond component (adding further safety) while decreasing its stock component.  After all, if a retiree is going to be withdrawing funds to live off, they won’t want their money gyrating wildly with the stock market.

Geniuses At the Helm

There’s a company called “American Funds” that sells actively managed stock and bond funds.  As far as actively managed funds go, they have a solid reputation.  Entering the “Target Retirement” fund market in 2007, they provided one-stop shopping for investors:  blends of their actively managed funds within a single fund, and again, with a bond component that is supposed to increase as the investor ages.  This fund company has a keen group of advisors who enjoy selling these funds to clients, mostly because the advisors get a full 5.75 percent of every penny an investor deposits into one of these funds.  But are investors getting good value for their extra expense?  Let’s have a look.

Cheapskates Sleeping on the job

Like the “American Funds” company, the non-profit investment group, Vanguard, has its own brand of “Target Retirement” funds.  But Vanguard (unlike American Funds) isn’t interested in paying commissions to brokers, nor do they have fat cats at the top of their pyramid who reap the rewards of the company’s profits.

Unlike “American Funds”, Vanguard doesn’t employ highly trained traders to buy stocks and bonds for the funds within their “Target Retirement Funds.”  Instead, Vanguard compiles baskets of index funds.  Nobody trades stocks within an index fund, so there are no traders to pay salaries to.  Nobody researches stocks for indexes, so there are no researchers to pay.  And nobody will try to sell you a Vanguard fund.  Why would they, when they aren’t promised a commission?

The Tale of the Tape

Let’s examine the five year performances for three of the American Funds Target Retirement Funds, and compare them with three lower cost Vanguard Target Retirement Funds, between January 2007 and September 29, 2011.  It’s a short, five year time period, but let’s see if it reveals anything interesting.

We’ll put these funds in the ring with their most equivalent counterparts.  For example, if the American Funds have a Target Retirement fund with 30% allocated to bonds, then we’ll compare that fund to the Vanguard Target Retirement fund which most closely matches this bond allocation.

The first two going head to head will be Vanguard’s 2035 Target Retirement Fund and American Funds 2030 Target Retirement Fund.  Each of them has roughly a 10% bond allocation.  In taxable accounts, if these two funds made the same amount of money, the Vanguard fund would earn the investor a higher return because the Vanguard fund’s turnover (the amount of trading that goes on within the fund) is less than what takes place with the American Fund.  But let’s see if the American Fund can outperform the Vanguard fund, before taxes:

January 2007 – September 29, 2011-09-30

Fund	Amount Invested	Sales Charge	End Value
Vanguard Target Retirement 2035	$10,000	$0	$9,510
American Funds Target Retirement 2030	$10,000	$575	$9,086

The Victor:  Vanguard

Commentary:   The stock markets are currently lower than they were in 2007, so with these Target Retirement Funds allocated mostly to stocks, it’s not surprising that neither of them made money over the past five years.  That said, investors in American Funds suffered even further at the hands of fees.

More Bonds, more short term safety

Let’s compare two more Target Retirement funds, this time with bond allocations of roughly 15% of the total.  Will the more expensive American Funds prove their mettle this time around?  Let’s have a look.

Fund	Amount Invested	Sales Charge	End Value
Vanguard Target Retirement 2030	$10,000	$0	$10,290
American Funds Target Retirement 2035	$10,000	$575	$9,086

 The Victor:  Vanguard

Commentary:  With higher bond allocations, each of these funds performed better than the previous two Target Retirement Funds we tested.  But have a look at what the five year difference was between the two funds.  Again, the American Fund couldn’t overcome its higher fees.

More Conservative Still

The Vanguard Target Retirement 2015 and the American Funds Target Retirement 2015 each have similar bond weightings:  38% and 34% respectively.

From January 2007 to September 29, 2011 was the American Funds company able to redeem itself and prove to offer value for investors who chose its 2015 Target Retirement Fund?

Fund	Amount Invested	Sales Charge	End Value
Vanguard Target Retirement 2015	$10,000	$0	$11,230
American Funds Target Retirement 2015	$10,000	$575	$9,622

 Victor:  Vanguard

Commentary:  The American Funds company isn’t giving its customers everything they deserve…although they’re making their advisors very happy, with that chunky 5.75% commission. Unfortunately, as previously mentioned, even if the American Fund returns did equal the Vanguard returns, the Vanguard investor would pay fewer taxes on those returns, putting the advantage back in Vanguard’s court.

That said, I compared all of the Target Retirement Funds for Vanguard and American Funds—ensuring that I compared funds with similar stock/bond allocations. 

Were any of the American Funds able to overcome their sales fees and beat the Vanguard funds since January 2007?

Nope.  None of them did.

A Note To American Expatriates

When you save and invest for your future, most of your money is held in taxable accounts.  You don’t have the option of dumping the majority of your investments in an IRA.

For that reason, it doesn’t make sense to invest with actively managed products.  Your portfolios won’t likely keep pace with indexed portfolios, and you’ll pay higher relative taxes on your investment returns.

Unless you already have an account with Vanguard, it can be tough for expatriates to open one.  That said, there are fabulous businesses, like Assetbuilder, that are encouraging American expatriates to open accounts with them.

Assetbuilder also offers combinations of indexed portfolios, much like the ones we compared above.  And the 5 year returns earned by Assetbuilder’s indexed portfolios were even better than Vanguards.  It’s something to consider, if you’re sick of paying high investment costs.

For more information on the superiority of low cost investing, you can order my book, Millionaire Teacher, also available on Kindle.