From Low Cost to No Cost–the Index Fund Has Won

This month, the investment giant Fidelity began to offer two broad-based index mutual funds with zero purchase and management fees and no minimum investment.

This is the latest salvo in a healthy competition between mass-market investment giants Vanguard (which started the index fund revolution under the leadership of Jack Bogle), Charles Schwab, and Fidelity. The result of the competition is a victory for main street investors, who traditionally have played the role of peasants forced to pay lordly fees.

As the Wall Street Journal quipped in their coverage of the story, “the race to zero in the investing world has finally reached bottom.”


The two funds in question are variations on very broad indexes. One is US domestic (Fidelity ZERO Total Market Index Fund aka FZROX) and resembles the Russell 3000 index–a proxy for the total US market. The other is international (Fidelity ZERO International Index Fund aka FZILX), which buys the top 90 percent of stocks in terms of market capitalization in every market outside the US).

Fidelity also slashed the cost of most of its other index funds, which is great for folks like me with Fidelity retirement accounts.

Looking at their SEC filing to open these funds is kind of thrilling. Zeros all the way down. I got the filing from the message board Bogleheads, where there is a lively discussion about this development. If it were just marketing hype, these diehard index investors would be pointing it out, but the consensus seems to be that this is real, not smoke and mirrors.

An old chestnut on Wall Street, the title of a humorous book by Fred Schwed, is a rhetorical question: Where are All the Customers’ Yachts?

Nowhere. The customers got skinned. Their pelts where hung on the wall.Michael Lewis and others wrote some amusing books about this.

A businessman named Jack Bogle started Vanguard in the 70s with a counter intuitive idea: stop buying yachts and instead return the profits to shareholders. The company would function as a quasi nonprofit, where the shareholders functioned as owners. This structure allowed any profits to go toward making it cheaper to invest. For many years, Vanguard stood alone as the low-cost, investor-first option.

Within the past decade massive amounts of money have flowed into index (or “passive,” since they passively track market indices) funds for good reason. Here is some data from CNBC:

Flows out of actively managed U.S. equity mutual funds leaped to $264.5 billion in 2016, while flows into passive index funds and ETFs were $236.1 billion, according to data provided by the Vanguard Group and Morningstar. That was the greatest calendar-year asset change in the last decade, during which more than $1 trillion has shifted from active to passive U.S. equity funds.

This makes sense. Index funds usually reflect the best deal for a retirement investors and other casual market participants. Fidelity, Charles Schwab, and others such as Black Rock started to compete with Vanguard in order to capture as much of this avalanche of money as possible.

The big difference between Vanguard and these companies is that that they have a more limited ownership structure. Much of Fidelity’s owership is the private property of the Johnson family.

When a family-owned private company — one that built its reputation on active money management a la Peter Lynch — starts to offer market access without cost, that is a breathtaking development in my book.

So where will the competition go from here? Likely further in the everyday investor’s interest.A lot of the talk on Bogleheads was about how technically Fidelity’s move makes the cost of their funds comparable to Vanguard’s since Fidelity makes profit loaning stocks, whereas Vanguard returns these profits to shareholders. Yet Vanguard, which is massive, may move to match lower costs.

Of course many investors may retreat from index funds during the next protracted bear market. But for folks who can hold on throughout the cycles, no fee index funds are a gold mine.

Bogle is the Best

This interview with Jack Bogle, produced by the Motely Fool, is a good introduction to one of America’s greatest citizens. Bogle created the first index fund  on New Year’s Eve, 1975. Since then the company he founded, Vanguard, has lived up to its moniker by proving that ultra-low-cost passive investing wins the loser’s game being played in the Wall Street casinos. I just finished reading Bogle’s Little Book of Common Sense Investing, which backs up his simple investing philosophy.

What I respect about Bogle is that he calls out the greed that robs average investors. He set up his company to be investor-oriented rather than profit oriented. The result is that everyone can be rewarded. The interview is great because it’s being conducted by a stock picker, Tom Gardner, who nonetheless lionizes Bogle the anti-stock-picker.

Watch the video, then read the book. You too will become a Boglehead.

A doodle of economic forces

Sometimes it’s fun to create economic flow charts on loose leaf paper or cocktail napkins.

This is a simple doodle of how I conceptualize the positive and negative monetary flows related to labor and capital.

Labor and Capital
Illustration by Dan Wilcock, created using Lucid Chart

Being neither an economist nor a mathematician, I find it best to follow the keep it simple stupid (KISS) principle, and for me this is about as simple/stupid a representation of this vastly complex topic as I can come up with.

Leftward arrows are generally negative in nature. Rightward are positive.

Micro Rentier

By Dan Wilcock

Merriam-Webster defines the French word rentier as “a person who lives on income from property or securities.” Here in America, rentier is an uncommon word. Word’s spell-check underlines it.

But it may become a lot more common thanks to Capital in the Twenty-First Century, the bestselling 700-page overview of inequality in rich countries by Thomas Piketty. I just started reading it, and found myself looking up the word in the dictionary. He uses rentier frequently to describe people whose income derives from capital assets instead of direct payment for labor.

Even though Piketty’s book brilliantly uses data to show that the rentiers are grabbing an increasingly large percentage of total wealth, I can’t help but notice that the lines between rentiers and laborers are increasingly blurring in the rich countries he studies.

A great example of this blurring is the so-called “sharing economy,” which was the focus of a cover story in Wired magazine this month subtitled “how Airbnb, Lyft, and Tinder are teaching us to love strangers.”

Is the owner of a late-model car who moonlights on nights and weekends by driving sloshy revelers around town for Uber a worker or a rentier? A bit of both, I think.

The Wired article opens with a day-in-the-life narrative of a 30-year old woman who works as a freelance yoga instructor and personal trainer when not picking up rides through Lyft. Doesn’t sound like dynastic wealth to me, but nor does it sound much like 9-to-5 for a pay-check labor.

I think the web is turning folks into micro rentiers. Traditional income streams, measured in per capita income and unemployment stats, may have flat-lined in recent years, which is a big factor in the rise of inequality. But the web is making it easier to unlock the asset potential of privately-owned stuff like cars and houses that until now were mostly financial liabilities.

I personally haven’t become a micro rentier yet. Security, privacy, and serenity are all things for which I’m willing to pay the opportunity cost of foregone income. But if I were squeezed, I’d definitely consider sticking my toe in these waters. Our economy may well squeeze most of us into these markets in the next few years, at least those without the keys to dynastic fortunes.

Cloudland: Why Iceland’s a Natural for the Cloud

(Image: Wikimedia Commons)
(Image: Wikimedia Commons)

By Daniel Wilcock

In 2008, the banking system of Iceland systematically failed, which led to a financial crisis from which the Nordic European island country is still recovering.

What does this have to do with cloud computing?

Iceland got rich temporarily through high finance, but it was boom and bust.  In the aftermath of this painful episode, this island comprised mostly of a “cold and uninhabitable combination of sand, mountains and lava fields,” must find a sustainable economic growth alternative.

Cloud computing can be that alternative. Consider:

  • Data centers require a lot of energy, but Iceland has a steady supply of thermal energy—enough to power the centers entirely through natural energy.
  • Data centers use less energy when the ambient temperature is lower and Iceland’s name says it all. The year-round climate is chilly. Combined with the steady energy supply, those cooler temperatures ensure further energy efficiency.
  • For security and risk mitigation reasons, data centers are best situated in sparsely populated areas. Iceland is one of the world most sparsely populated countries.

A Rapidly Expanding Market

According to the technology research company Gartner, the market size of public cloud services in 2013 is $131 billion and its 2013 growth rate will be 18%. The same study found infrastructure as a service as (IaaS) the fastest-growing component of the cloud market.  IaaS grew 42.4 percent in 2012 to $6.1 billion. This year the increase is predicted to be 47.3 percent.

Cloud computing, particularly IaaS, represents a good opportunity for return on capital invested by any entity. Yet Iceland has significant advantages that would make its return on investment greater than competitors in other counties. Those advantages are natural geothermal energy and an environment conducive to both greater efficacy and better security, factors described below.

Cloud computing is also a better alternative than the recent explosion of aluminum smelter operations in Iceland—an industry that already consumes five-times the amount of electricity as Iceland’s residents. As the financial crisis taught, over-reliance on one industry creates significant risk. Cloud computing can be a balancing factor that will reduce this risk.

Solving Cloud Computing’s Energy Crisis

Not only would Iceland’s economy benefit from a major investment in cloud computing, the cloud computing market would benefit greatly. This is because the data centers that make cloud computing possible use vast quantities of electricity. By one estimate, a typical server farm uses the same amount of power as 180,000 homes. Iceland’s historic investment in capturing geothermal energy has paid tremendous dividends. Currently 25% of electricity usage in Iceland is from geothermal, with almost all of the balance coming from hydro-power.  This gives data center operations in Iceland four distinct energy advantages:

  • Abundant, cheap power
  • Green power
  • Power derived from a source unlikely to fail suddenly
  • Cooler ambient temperatures that reduce the need to use power to cool servers, making data centers more efficient

If the data revolution continues to grow exponentially within a context of worsening global environmental problems such as climate change, companies around the world will be under pressure to find eco-friendly solutions for cloud computing. Some companies are already showing the way in Iceland. An Icelandic startup called Greenqloud offers a “sustainable public compute cloud that is 100% carbon neutral.” They have been joined by Verne Global, a British company that offers similar 100% renewable-energy services.

Yet one big potential disadvantage to making Iceland “cloudland” must be mentioned: Iceland’s abundant geothermal power comes from the island’s volcanic character. A major eruption could wipe out one or more centers. This risk can be mitigated by locating all data centers in areas far from the ridges on which Iceland’s volcanos rise and seeking protective land formations that would shield from lava flows such as natural or man-made caves.

In the past Iceland has been the victim of its unforgiving geography, which is not conducive to farming or dense population. The era of big data could flip this reality, making Iceland’s low temperatures and abundant natural energy the nation’s signature assets.

Amherst’s Faculty: Dignity and Solidarity over MOOCs

By Dan Wilcock

The 70 to 36 decision by faculty members at Amherst against accepting an invitation to join EdX, a pioneer in the field of massive online open courses (MOOCs), signals to me that there’s some hope for higher education.

EdX is good at making education more widely available. For millions of people around the world who might not otherwise be able to catch a glimpse of a Harvard classroom, much less matriculate in Cambridge, MOOCs offer the educational equivalent of window shopping. It will never be like sitting in the classroom and interacting with the professor, but you can see what the class has to offer. Even if you never “own” the class in the form of a something that will add up to a degree, you can be get the gist of a topic and self-study your way to mastery.

I think the profs at Amherst, one of America’s best liberal arts schools, placed the right bet. MOOCs are part of the pattern that Jaron Lanier describes in Who Owns the Future?, a fantastic book published this month, in which “ordinary people will be unvalued by the new economy, while those closest to the top computers will become hypervaluable.”

The Chronicle of Higher Education article cited above states that EdX, which was founded by Harvard and MIT, has only 12 partner institutions, but has received membership inquiries from 300 colleges and universities. A lot of schools want to get on this bandwagon. Yet Amherst, when offered a coveted seat  “closest to the top computers” (to use Lanier’s terms), it did two remarkable things:

  • It put the choice to a real vote among the faculty
  • It allowed faculty members, many of whom have clearly thought through the implications of building a video database that may threaten their livelihood and those of their peers, to frame the debate

This example of democracy and public reasoning leading to a rejection of a coveted invitation from Harvard/MIT to join the shiny-new-cloud solution to higher education is refreshing to witness. The faculty committee is correct to observe that MOOCs will “enable the centralization of American higher education.” Whether MOOCs will “create the conditions for the obsolescence of the B.A. degree,” is something I’m not qualified to judge, but viewing the stakes starkly demonstrates wisdom. Putting lectures in the cloud may seem smart today, but when thousands of professors start to get laid off it will be clear exactly whose lives the technology intended to disrupt.

I don’t support the educational bloat and skyrocketing tuition that have led to the educational bubble, but I also don’t support laying off massive numbers of people who are central to America’s character. When the bubble pops, the MOOCs will be a convenient cost-cutting tool. In the Amherst committee’s language, I sense they are proactively voting in solidarity with professors across the country.

As I wrote before, I don’t think MOOCs spell the end of higher ed. Amherst’s wisdom makes me more confident in my prediction.

Medical bills and human freedom

By Daniel Wilcock

Time Magazine’s recent cover story on medical bills is an exhaustive, painful-to-read reminder about how out of whack America’s system of paying for health care has become. The stories of individuals not insured or covered under Medicare being charged 400% more than the Medicare rate for the same services reveals a bitter irony: those who have the least protection, such as the underemployed, get charged the most.

America has a problem with medical bills, the staggering proportions of which the article outlines:

“According to one of a series of exhaustive studies done by the McKinsey & Co. consulting firm, we spend more on health care than the next 10 biggest spenders combined: Japan, Germany, France, China, the U.K., Italy, Canada, Brazil, Spain and Australia. We may be shocked at the $60 billion price tag for cleaning up after Hurricane Sandy. We spent almost that much last week on health care.”

Reform measures, such as the Affordable Care Act, are vitally important—and not only for the sake of bending down the cost curve.  Human freedom and the pursuit of happiness are also in the mix.

As the Time piece attests, Medical bills are an ever-present risk for everyone, especially those not covered by private insurance or government programs.  The risk of medical bills ties workers to jobs.  Starbucks deserves praise for offering family health insurance to part-time workers (a financial lifeline).

In a column called “A world without work,” New York Times columnist Ross Douthat wrote last week about how we are heading into a new labor paradigm where work becomes scarcer:

“IMAGINE, as 19th-century utopians often did, a society rich enough that fewer and fewer people need to work — a society where leisure becomes universally accessible, where part-time jobs replace the regimented workweek, and where living standards keep rising even though more people have left the work force altogether…Yet the decline of work isn’t actually some wild Marxist scenario. It’s a basic reality of 21st-century American life, one that predates the financial crash and promises to continue apace even as normal economic growth returns.”

Sounds intriguing, but the trend in medical bills makes this picture less rosy, both for individuals and for the government.

I’m all for a society in which people are free to pursue endeavors that give them purpose, rather than just holding down jobs. In the society that Douthat describes, this kind of freedom might become more commonplace. The financial plan presented in the popular book “Your Money or Your Life” helps thrifty people work to a level of wealth in which it’s no longer necessary to work a 9 to 5. This gives them time to pursue things that matter to them and to their communities. Yet the risk of medical bills can scotch the freedom dreams of even the most prodigious wealth accumulators.

America faces a massive challenge in fixing this impediment to freedom. My guess is that the next couple of decades will present many dilemmas that will force some big fixes. Hopefully we’ll be able to look back on this Time cover story as a turning point.

Market’s back, but people aren’t

Dow high
The Dow hit its highest point since December 2007 this week. (Image: Google)

By Daniel Wilcock

The American stock market, as measured by both the Dow Jones Industrial Average and the S&P 500, closed yesterday at its highest level since December 2007.

Ordinarily, as a low-cost index investor, I agree with market sages such as Burton Malkiel and John Bogle, who caution investors not to pay much attention to the daily soap opera of market fluctuations. But somehow this particular milestone means something to me.

In April of 2008, I relocated to the States from Japan, where I’d been living the previous two years. Luckily, I found a nice writing job at Georgetown University (a relatively safe harbor within stormy seas) shortly before the markets went to hell and employers started shedding their payrolls. When the Lehman collapse happened, I can clearly recall the indexes going down 5% each day for several consecutive days.

Those dark days always made me flash back to the summer of 2007, when my wife and I took a honeymoon in Finland and Denmark. Each day, I had the luxury of perusing the International Herald Tribune in a leisurely way. That splendid summer, the financial news was filled with warnings of a coming market catastrophe, evidenced by the failure of some mortgage-related funds at Bear Stearns.  Yet the market continued to go up in the following weeks.

We may be approaching a conclusion to those days of frozen credit and a hemorrhaging housing market. In my opinion (which I admit is quite different from Wall Street types), The Consumer Financial Protection Bureau is leading our housing and credit economies to a brighter future. In this regard America may be learning something from Canada, which didn’t have a mortgage crisis.

But what about the 8% of workers in America and more than 50% of young people in countries like Spain who wish to enter the workforce, but can’t find their way? I’m looking for ways to be optimistic about the future of labor in the new era we’ve entered. B corporations and the GIIRS index inspire me, as do companies and organizations that take environmental and community sustainability seriously.

The market’s return is an indicator of our collective wealth. The unemployment problem is an indicator of our collective poverty. My hope is that our markets will evolve and bring their productivity to bear on the social and environmental problems we face.

Idealistic, yes. Naive, perhaps. But optimists live better lives.