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SMay 31, 2013

The Universal Retirement Tool

Scott Burns

Free market competition has delivered to working savers what five decades of legislative effort has failed to provide— virtually universal access to low-cost investing.

How low? Try this. The Federal Thrift Savings Plan (TSP) enjoyed by government workers has long been the lowest cost 401(k) plan in the country. It has an annual cost of 3 basis points. That’s three one-hundredth’s of one percent. This reduces the cost of retirement saving to essentially trivial levels, enough that the vast majority of the return on investment goes to the actual saver, not the financial services industry.

The cost of the TSP is so low that the Investment Company Institute, which represents the nations’ mutual fund firms, felt compelled to declare that the TSP was priced at an artificially low level and could not be used as a model for private sector plans. That was in 2008. Today, several of the largest financial services firms are competing to offer IRA accounts where it is possible to manage our money for about 10 basis points.

In comparison, the average expense ratio of all balanced mutual funds is 1.26 percent— nearly 13 times as much.

Only a handful of very large company 401(k) plans approach the low cost of the Thrift Savings Plan— companies like Exxon Mobil, IBM and Texas Instruments. Yet today anyone, anywhere in America, can invest at about the same cost. This includes the waitress/bartender whose email I answered in a recent column. Equally important, it can be done at many firms.

Being able to do low-cost investing at multiple firms is important. For many years only one firm made an effort to dramatically reduce fees— Vanguard. It was the first mover in the creation of low-cost index funds. It had the field to itself for several decades. No firm wanted to cut costs as Vanguard did.

But today index investing has been embraced. Morningstar counts nearly 2,500 index funds today, compared to only 295 at the turn of the century and only 15 in 1990. Better still, the burgeoning exchange traded fund industry has driven the retail cost of investing down to near-TSP levels.

Don’t get me wrong: Wall Street still manufactures and markets high-cost investment garbage. Financial firms continue to introduce increasingly weird and expensive exchange-traded funds. Today, there are 1,425 exchange-traded-funds, according to Morningstar. Many achieve richly deserved obscurity. Some are quietly closed, but others quickly replace them. Many others, as ETF expert Rick Ferri has observed, defeat the original purpose of exchange-traded funds. That purpose was to produce duplicates of major asset classes at low cost.

Fortunately, we can regard the majority of ETFs as useless garbage. We can ignore them. All we need to know is that there are no more than ten asset classes we should consider for investment and that most people will be fine with no more than six. Those ETFs are generally available from about four sources: Vanguard, iShares, Schwab, and State Street. And we can often buy them commission-free.

The table below, for instance, shows how to build my Couch Potato Margarita portfolio on four of the largest platforms: Ameritrade, Fidelity, Schwab and Vanguard. Investing in no-commission exchange traded funds only; Schwab takes the prize for the lowest cost at 0.07 percent. Fidelity is the most expensive with an average portfolio cost of 0.25 percent. (If you can make an initial investment of $2,500, however, you could use Fidelity Spartan mutual funds rather than ETFs and cut the cost in half, to 0.12 percent.)

How to Get Your Retirement Investing Costs to Rock-Bottom Levels

This table shows how to build comparable three-asset-class portfolios at four of the largest discount investment firms. In each case a diversified portfolio is built with three no commission exchange-traded funds.

Asset Class Ameritrade Fidelity* Schwab Vanguard
U.S. Broad Equity Market 1/3 Vanguard Total Stock Market (VTI; ER 0.05%) iShares Russell 3000 etf (IWV; ER 0.20) Schwab U.S. Broad Market (SCHB; ER 0.04%) Vanguard Total Stock Market (VTI; ER 0.05%)
International Broad Equity Market 1/3 Vanguard Total International Total Stock (VXUS; ER 0.16%) iShares EAFE etf (EFA; ER 0.34%) Schwab International Equity (SCHF; ER 0.09%) Vanguard Total International Stock (VXUS, ER 0.16%)
Inflation-Protected Treasury Securities 1/3 iShares Barclays TIPS (TIP; ER 0.20%) iShares Barclays TIPS Bond (TIP; ER 0.20%) Schwab U.S. TIPS (SCHP; ER 0.07%) Vanguard Short Term Inflation Protected Securities Index Fund (VTIP, 0.10)
Portfolio Cost= Average ER: 0.14% Average ER: 0.25% Average ER: 0.07% Average ER: 0.10%

Filed Under: Retirement