Last week, Morgan Stanley slammed the door on placing Vanguard mutual funds in client portfolios. Morgan Stanley’s decision follows a similar one instituted last year by Merrill Lynch to forbid new sales of Vanguard mutual funds. The brokerage arms of Wells Fargo & Co. and UBS Group AG, two of the other big traditional brokerages, will likely follow Morgan Stanley in dumping Vanguard funds out of client portfolios.
At a time when retail investors are clamoring for low-expense ratio index funds that Vanguard champions, why would these large firms not offer the Vanguard family of funds? The answer lies in Vanguard’s model which, in an effort to keep expenses low for investors, refuses to pay brokerage firms for what is known as “shelf space”.
Shelf space is the dirty little secret that brokerage firms and their financial advisors never tell their clients. In return for fees that run anywhere between $250,000 – $750,000 a year, brokerage firms give favorable treatment to certain mutual funds and recommend them above other funds to the clients. In order to recover the fees paid out to the brokerages, these mutual funds charge their investors sales loads and much higher fees or expense ratios (0.5% – 2% of assets) versus 0.25% or lower in Vanguard’s case*. Adding these fees on top of the advisory fees charged by the brokerages of 1.5% – 2.5%, client portfolios would need to have return of 2% – 4.5%, just to breakeven.
And so, if you are wondering why did your advisor put your money in an obscure high cost mutual fund instead of a comparable low cost Vanguard index fund, now you know the answer.
Future Wealth’s View
As investors exit out of high cost actively managed mutual funds and advisors into low cost passive ETFs and index funds, it is inevitable that these large brokerages who have been thriving on exorbitant advisory fees, shelf space, preferred partner programs and other hidden fees have to adapt to the new reality. However, much like retail stores that are in denial that Amazon is eating up their business, these brokerages continue to gouge their customers and believe that the good old days will last forever.
Future Wealth was founded on the premise that the clients do not need to pay more than 1% of assets, all in (advisory fees included)** to build a sound portfolio and financial plan. With no affiliation or revenue sharing agreements with any preferred partners, the Vanguard family of low cost products is our “go-to” investment and makes up the majority of our client portfolios***. We believe in putting clients’ interests first – what a novel idea!