Like Walmart arriving in a new town, the entry of Vanguard into a particular investment area causes a collective gnashing of teeth as other fund managers are forced to drop their prices to compete. That dynamic is borne out in the table below, which shows the cheapest ETF fees for products that do or do not have a Vanguard-provided equivalent.
All of which raises the question of how Vanguard manages to make its own profit in the face of ultra-low fees.
Vanguard's ability to achieve extremely low costs can be traced back to the way founder John Bogle formed the company in 1975. He set it up as a "mutual ownership structure," which basically means the shareholders are the fund investors. So while Vanguard does make profits, those profits don’t go to shareholders, they go back to investors by lowering fees. The foundation on which Vanguard is built is what makes it so different and ultimately gives the company its edge.
Until now, the asset numbers probably weren’t big enough to trouble Wall Street, but as Vanguard is now on pace to add a cool $1 trillion in assets every few years, it is effectively becoming a massive wealth transfer machine funneling money out of the financial industry and into individual investors’ accounts.
So how does this story end? Right now, passive products, such as index funds and ETFs, have about 30 percent of the $16 trillion in total investor assets, compared with active products, which still have 70 percent. If the balance of power were to shift firmly in passive's favor, one might expect extra opportunities for stock- and bond-picking active managers to emerge, since there would be more inefficiencies in a market where the majority of investors are invested equally.
If active managers exploited those inefficiencies—a valuable role played by traders and portfolio managers—and outperformed the market, some money would inevitably move back to them.
So while Vanguard has enjoyed a stunning run in recent years, there are arguably natural limits to its dominance.
Still, the effects of Vanguard's rise have been far- reaching on Wall Street, prompting fees to come down across the industry. It is a major reason why Vanguard is now pushing more reform on Wall Street than all the political rhetoric in the world.
*Of course, this applies only to Vanguard’s index funds, which account for about two-thirds of its total assets, or $2 trillion.