Vanguard made an incredible announcement in October 2010: The minimum investment requirement for their Admiral Class shares were lowered from $100,000 to $10,000 for index funds and to $50,000 for actively managed funds. The lower minimum investment requirement makes the Admiral Class accessible to a large number of investors previously locked out. This is effectively a fee reduction as the Admirals’ expense ratios are from 0.07% to 0.17% cheaper than the investor class.
There are over 50 Vanguard funds with Admiral Class shares, all of which are included in this change. For example, the Vanguard Intermediate-Term Bond Index Fund Investor Class (VBIIX) expense ratio is 0.22% while the Admiral Class (VBILX) is 0.12%. Similarly the Vanguard 500 Index Fund Investor Class (VFINX) expense ratio is 0.18% while the Admiral Class (VFIAX) is 0.07%.
However as with many good things, this change comes with conditions. The Admirals shares are now almost exclusively available from Vanguard Brokerage. Looking at other retail brokerages such as Schwab, Fidelity, Scottrade and E*Trade you will find the Admiral Class of shares either not available or only open to existing owners. They are also not available on Advisor platforms such as Pershing. I suspect that they may be available for certain institutional or qualified plan arrangements, though I do not know for sure.
Admiral or ETF?
This change can be seen as another step in Vanguard’s long history of dropping investor expense ratios. It is also a very smart marketing strategy providing another incentive for investors to move their assets to the Vanguard Brokerage. Or is it? It turns out that almost all of the index funds with Admiral Class shares also have ETF class shares. And guess what the expense ratio is for these ETF’s? Almost all are the same as the Admiral Class shares with some ETF’s even lower!
So in reality every investor can share in the lower expense ratio of Vanguard Index Fund Admirals regardless of their brokerage by buying ETF’s. In addition to the lower costs ETF’s typically have no capital gains distributions. Although there were capital gains distributions with some ETF’s for the first time at the end of 2010 they were still lower then for most mutual funds.
.You might have noticed that I said “ETF Class”. That is because due to Vanguard fund’s unique structure, the ETF’s are actually just another share class of the Fund. This means that they share in the economies of scale of the existing assets in other fund classes and so are able to be offered at the lowest expense ratio.
Conversion Considerations
Should you switch you existing Vanguard Shares to Admirals or ETF’s? If your funds are held at Vanguard, they should have been automatically converted to Admiral Class shares at the end of 2010 if you met the minimum investment requirement. For investors at other brokerages (or those at Vanguard with less $10,000 in an index mutual fund) the decision and timing to move to the ETF class should be based on an analysis of management fee savings, your holding period, transaction fees and tax consequences.
Example
Let us look at an example to understand the potential benefits. Assume an investor owns $20,000 of the Vanguard 500 Index Fund Investor Class (VFINX) at Charles Schwab with a cost basis of $15,000 in a taxable account:
VFINX Fund annual expense (0.18%) = $36
VOO ETF annual expense (0.06%) = $12
Online Fund sale transaction fee: $49.95
Online ETF purchase transaction fee: $8.95
There would be a $24 annually by converting to the ETF. However it would cost $58.90 to do so. It would take about 2 1/2 years to breakeven. If the ETF was going to be held longer than this than changing to the ETF would make sense if the tax consequences were acceptable.
In our example there would be a $5000 capital gain. Assume it is a long term capital gain and that the owner has $6000 in long term capital losses. In this case the fee reduction could be achieved with no income taxes being paid.
Conclusion
If you are an investor now holding the investor class of Vanguard Mutual Funds which have an ETF’s class you should evaluate whether a move would be beneficial to you. The decision and timing to move to the ETF class should be based on management fee savings, your holding period, transaction fees and tax consequences.
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