CAHPTER 19

LOOKING AHEAD

With its ability to raise over $5 billion of capital to finance a major commitment, low-cost, low-margin Vanguard has become a strategic financial powerhouse. As Buckley and his board and management team look ahead, the Vanguard flywheel can generate substantial financial resources that begin with a very small percentage in fees and yield a very large total capacity to invest in new capabilities, services, and products. That enormous financial power will enable Vanguard to disrupt the mutual fund industry again—and again.

One basis point is tiny: a mere one-hundredth of 1 percent. But even something so very small, when multiplied by a very large number, can become quite big. Vanguard now manages over $8 trillion: $8,000,000,000,000! So a tiny 1 basis point in fees equals $800 million every year to invest in new, high-impact strategic moves. This gigantic sum could be earned by Vanguard simply not reducing fees quite as much as it might, or by raising fees ever so slightly. If you were Vanguard, what might you do with over $800 million of financing for new ideas and new capabilities every year?

Consider for a moment a thought experiment: If Vanguard decided to spend $100 million of that $800 million on carefully collecting and rigorously analyzing the past behavior of its 30 million individual investor-owners, might it achieve a game-changing advantage that would enable it to serve clients better in compelling ways for years to come?

For a small fraction of that annual $800 million, Vanguard could offer 10 million of its investor-owners appropriate incentives to spend half an hour with a well-designed multiple-choice survey asking them to describe themselves with a few financial metrics: income, annual retirement savings, size of portfolio, and major investment goals; answer some questions about their investment behavior (for example, time and interest in investing, past investing behavior and concerns such as retirement security, health-care costs, education for children or grandchildren, home purchase, intergenerational bequests and charitable giving); and indicate where they are most and least concerned on a series of dimensions: saving for kids’ college, for a family home, for vacations, or for retirement.

Ask what they wish they had done financially in the past 10 years to improve their present financial position and what past mistakes they most regret, like trading too much, saving too little, trying to time markets, or holding so much in bonds. What do they intend to do differently over the coming year, ten years?

Vanguard could divide and analyze the responses by age in five decades, by five major income levels and by five levels of wealth. With 1 million participants, if the data were divided into five age groups, and each of these into five wealth and income categories, and each of those into five “risk attitude” categories, each “cluster” would, on average, still have a sample of participants large enough for rigorous analysis.

With such a large sample in each cluster, all sorts of analyses could be done, particularly if participants agreed to re-participate—perhaps at two-year intervals or as markets rise and fall and participants live through changing life and financial experiences. Vanguard could organize, analyze, and make valuable information available to investors—perhaps with a follow-up call from a Vanguard adviser to identify specific ways to make fewer, better financial planning and investing decisions.

Could analysts identify important realities that would help 30-year-olds (or 40- or 50-year-olds) see themselves as they will most likely be in 10 or 20 or even 30 years—and so help them make better decisions now? Vanguard investors could quietly observe their own “virtual futures” by seeing what investors just like them but 10 or 20 years further along in their lives have done or are doing, or not doing; what they wish they had done differently; how they feel now about their finances and how they might want to improve. What mistakes can I avoid because I’m getting to see my probable personal financial future thanks to Vanguard? Could this exercise help me make better decisions? Could it help me avoid mistakes? Could Vanguard give me a few helpful nudges toward making my own best moves? If Vanguard offered the results of this sort of research, at a modest fee or free to all who participate, would investors feel well served and even more loyal to and likely to use Vanguard even more?

If Vanguard concluded that this survey idea worked well, would it be able to develop more ways to invest other parts of that annual $800 million in developing several other ways to engage the interests and loyalties of its investors? As a consequence, might it increase its “share of wallet” with current Vanguard investors? Might it attract many more investors who appreciate the new services?

Or, to go in a different direction, could Vanguard decide to invest several years of development funds in building up its business in a series of other countries and allow itself five or even 10 years to earn back those costs of bringing the benefits of Vanguard to international investors?

If investing $800 million every year is promising, but not enough to accomplish “everything,” could Vanguard invest even more by increasing, or not decreasing, fees by just two basis points? That could permit investing over $1.6 billion every year in developing extraordinary expertise and new technology to help its clients—or help financial advisers help their clients—pursue custom-tailored investment advice programs and “stay the course”?

Every year, Vanguard leadership is now in the powerful position of deciding how best to invest the extraordinary accelerating power of its flywheel on behalf of its many millions of investors. Every year, Vanguard can invest in either further reducing fees or in further increasing the value it delivers—or both. It is able to accelerate the flywheel and increase the value of its services to each investor, and so attract more of each investor’s assets—and continue to disrupt the traditional investment industry with innovations.

Advice may recently have opened a major market—perhaps the world’s largest future investment market—to the service capabilities of Vanguard: China. In late 2019, Vanguard and Ant financial services group announced the formation of a partnership that would offer to help China’s investors select mutual funds from the 5,700 funds now on offer through Ant, which, as a reminder of the potential scale, has 900 million people now using its Alipay service. The Chinese stock market is now dominated by amateur investors. While they will surely give way in the future to expert professionals with excellent research and technology, as in other major markets, at present actively managed mutual funds in China can and do outperform index funds after costs and so can charge high fees.

Ant and its founder, Jack Ma, have recently been under pressure from the Chinese government, which blocked Ant’s initial public offering and put its mutual fund operations under the supervision of the central bank. But Vanguard remains committed to the joint venture, which has always been regulated by the Chinese government. Vanguard said, “We continue to invest in the growing venture, which is now providing risk-appropriate, diversified, and high-quality mutual fund portfolios to more than 2 million Chinese investors. That’s 2 million clients who are better off in well-managed, long-term oriented funds, in just over one year of operation—a clear testament to Vanguard’s mission to improve investor outcomes worldwide.”

In recent years, while gaining international business overall, Vanguard has had various disappointments. In October 2020, it returned $21 billion to Chinese government clients to focus on individual investors, then in March 2021 suspended plans to launch mutual funds in China. In addition, it has been withdrawing from Japan, Hong Kong, Taiwan, and other difficult international markets. Going global with financial services has always been hard; only a few have succeeded greatly. One reason is the remarkable reluctance of investors to entrust their investments to “foreign” managers. Another is the protection by regulators in almost all countries of their nation’s own financial service organizations—banks, insurance, securities dealers, and investment managers. Regulators know what they should do for investors in their home markets, but actually making the changes can be politically difficult.

Vanguard has fallen behind key competitors like Fidelity and Schwab in service to investors. The reasons range from the firm’s explosive growth in assets to its long-ago reluctance to automate, compounded by pandemic-era challenges with many representatives working remotely. The problems are multiple. Routine service requests can take hours, not minutes, to resolve. Mistakes are made. Requests for custom service can get a “We don’t do that sort of thing” response. The troubles haven’t visibly affected growth, particularly in new accounts, and extensive corrective measures are showing some results. While this is a problem that can be solved, it has been a serious error to allow it to become widespread.

Both Vanguard and Fidelity are making major investments in their futures, confident that cost of developing strong client relationships will pay off handsomely over the long run. Vanguard has introduced new contact center technology, reorganized client service teams, and accelerated efforts to redesign and improve clients’ digital experience. A spokeswoman notes that one recent evaluation, J.D. Power’s 2021 U.S. Self-Directed Investor Satisfaction Study, ranked Vanguard first in self-directed investor satisfaction among investors seeking guidance and among do-it-yourself investors.

Fidelity has been expanding its workforce substantially; in September 2021 it announced plans to hire 9,000 new workers, a 22 percent increase in its staff, taking the total to more than 60,000. This enormous commitment, its third in a year, is in response to the surge in new individual market participants. In the year ended in June 2021, Fidelity added 1.7 million retail accounts, including 697,000 for people under 35. Of the 16,000 new hires Fidelity expected to make, nearly 80 percent would be in client-facing roles. Fidelity is also expanding its technology support staff and adding new services.¹ With a wide variety of services on offer, including the bill-paying service Vanguard discontinued, Fidelity’s strategy appears centered on finding ways to add new accounts with the expectation that new customers will decide to add more and more services to their initial relationship with Fidelity.

Vanguard anticipates more focus on advice services in its future international expansion, with particular interest in 10 countries, including the United Kingdom and Australia, with large potential and fewer constraints designed to protect local banks. The still-untapped possibilities for transforming advice-giving at home and abroad remain vast.

Like almost all investment managers today, Vanguard’s investment advice is based only on an investor’s portfolio of securities—cash, stocks, and bonds. This focus seems too narrow. It leaves out such stable-value assets as the investor’s home, future Social Security payouts, and the present value of future earnings and savings—and for some, future bequests—all of which matter financially. While understandable, this blinkered approach can be seriously misleading. One danger is an overemphasis on fixed-income investment such as the old “invest your age in bonds” rule, which would have a 40-year-old with a sizable, steady income choose bonds for a substantial 40 percent of a securities portfolio that won’t even begin to be tapped for retirement for 25 or 30 years. Investment advisers should direct clients’ attention to all the various parts of their whole financial picture, not just the securities portfolio part.

The business of providing financial advice is driven by scale. The big investments now at Vanguard’s disposal can finance breakthroughs in automation, allowing differentiated, individualized services previously unimagined and compelling to investors. Vanguard has made huge changes in the investment business in every decade of its past. In the next decades, it is certain to do so again.