Brokers and fund managers
This post is part of the Financial Freedom Guide series
When deciding who to entrust your money with you need to pick:
A broker who will buy, sell, and manage your securities, and
What specific securities to purchase - preferably broad market index funds reflecting your asset allocation
Brokers
You want your broker to be:
Trustworthy
Easy to use
Low cost
This means low or no account minimums and low or no account maintenance, trading, or other fees. It also means no payment for order flow or other funny business (looking at you, Robinhood).
Man, there go the sponsorship opportunities for this blog… If you like my independent content and would like to encourage me to keep it going, consider buying me a coffee?
What your broker options are will depend greatly on what country you are investing from. I'd like to add articles synthesizing options for different countries over time. If you are an expert on your country's brokerage and index fund options and would like to share your advice and/or write a guest post, please hit me up in the comments or contact me directly!
Meanwhile, if you have the good fortune of investing from the United States, here are my top three recommendations:
The co-op: Vanguard - also active in many other countries
Competitive for-profit players: Schwab and Fidelity
Robo-Advisors: Wealthfront and Betterment
The co-op: Vanguard
Vanguard is the world's largest provider of mutual funds (and #2 for ETFs) with more than $7T (yes, that's T for Trillion!) assets under management. Alongside BlackRock and State Street, Vanguard makes up the top 3 index fund managers in the US and globally.
Vanguard is unique among its peers in that its management company (The Vanguard Group, Inc.) is owned by Vanguard's own funds and so, indirectly, the investors in Vanguard funds themselves. The other players in the market - like BlackRock, State Street, Schwab, and Fidelity - are all publicly traded companies looking to make money off you, the investor, to generate returns for their shareholders. Vanguard as a co-op on the other hand passes any such earnings directly back its investors in the form of lower expense ratios. Simply put, Vanguard's incentives are aligned with yours.
And it shows. Vanguard launched the world's first index fund in 1976 and has been a pioneer and driving force behind low-cost index investing ever since. In fact, it took them all the way until the 1990s to really take off as they refused to pay commissions to brokers and advisors to sell their funds and this slowed their growth. Vanguard funds are frequently the largest and most liquid funds in their respective categories and almost always the lowest cost option.
Vanguard also offers brokerage services. Their brokerage accounts in the US come with zero account account fees and zero trade fees for stock, ETF, and Vanguard mutual fund trades. That combined with their index funds is a powerful low-cost option to manage your portfolio.
You will find that Vanguard brokerage accounts don't come with some of the fancy technical analysis and trading tools you might expect from other online brokers. But then Vanguard exists for your long-term investment success rather than to entice you to engage in as many speculative day-trading transactions as possible to collect trade commission fees from you for their shareholders.
If you want to rest easy knowing that your broker (and index fund issuer) has your best interests at heart, open a Vanguard brokerage account and invest in Vanguard index funds - be they mutual fund or ETF shares (coming soon - subscribe to encourage us to hurry up). You'll sleep better this way.
Competitive for-profit players: Schwab and Fidelity
While both Schwab and Fidelity are for-profit brokerage (and index fund) providers, they have traditionally been unusually investor-focused and cost competitive. Their index funds tend to be high quality and only slightly more expensive than Vanguard's funds. You may well encounter these players as managers of your employer retirement accounts and I’m personally comfortable entrusting them with my money.
In fact, you will see that I recommend Schwab index fund ETFs as excellent alternatives to Vanguard funds for tax loss-harvesting. I'm also a huge fan of Schwab's Investor Checking account (coming soon - subscribe to encourage us to hurry up) and use it as my primary checking account.
Robo-advisors: Wealthfront and Betterment
Robo-advisors promise to take your money and automatically invest it according to all the best practice investment advice you will read about in this blog. This is a very alluring offering that is hard to resist - a one-stop shop, set it and forget it approach. And if that's what it takes to get you to save and invest, please, by all means go ahead and invest with them. I myself used to be an avid Wealthfront customer (coming soon - subscribe to encourage us to hurry up) and referred over a dozen of my friends to start investing with them.
In fact, at this point I'd love to be able to say: Hey, here are my referral links. If you'd like to support my blog, go ahead and click through from here. Unfortunately, I doubt Wealthfront or Betterment are going to sponsor this blog.
Here is why I no longer recommend robo-advisors:
As good as their service can be if you use them right, their incentive is still to make money off of you. Preferably quickly, as those venture capital investors want profitable exits. This can lead to some unfortunate developments (coming soon - subscribe to encourage us to hurry up).
If you are following this blog, there is a good chance you are pursuing Financial Freedom. That means you are aiming to accumulate million-dollar account balances. At those balances even a moderate 0.25% robo-advisor management fee adds up. $1M invested for 40 years at 7-8% real market return would net the robo-advisor about $1.5-2M in "low" 0.25% management fees on top of whatever other investment costs you'd incur. I'd rather you get to spend that money on yourself. Of course that will only happen if you actually implement the advice on this blog. If you don't, a robo-advisor may indeed be your best choice.
Robo-advisors are very much geared for the accumulation phase of your Financial Freedom journey. But once you reach Financial Freedom, other considerations come in. Instead of tax loss-harvesting, you may want to start engaging in tax gain-harvesting, for example. Robo-advisors aren’t usually set up to support this.
Robo-advisors need to come up with a one-size-fits-all investment recipe that suits all of their investors. Sure, they may segment their investors by “risk scores” but those don't account for the marginal tax bracket you are in today or in the future. So their allocation to tax-free US municipal bonds, for example, may be geared towards a high-earning Silicon Valley software developer - like the wonderful folks who work at these robo-advisors and the people they are surrounded with every day - rather than your particular financial situation.
Fund managers
OK, so you opened an account with one of the above providers. What specific index fund securities should you consider?
You want your index funds to be:
Invested in an index reflecting one of the asset classes in your asset allocation
Issued by a reputable provider (e.g., Vanguard, Schwab, BlackRock)
Large, with sufficient assets under management (say, $1B+) to be highly liquid and allow you to buy or sell them any time with minimal transaction costs (e.g., bid/ask spread)
Old enough (preferably 5+ years) for you to assess its "tracking error". This measures how closely the fund tracks their index both in terms of price movements as well as the number and mix of stocks/bonds vs the index
Low cost as expressed by a low expense ratio, without any other purchase, redemption, or other management fees
An ETF (or Vanguard mutual fund) for tax efficiency, ease of trading, and freedom to change brokers through non-taxable in-kind transfers (rather than selling, paying tax, and then re-buying)
Domiciled in a jurisdiction that is tax efficient for you. US taxpayers, for example - all US citizens and lawful permanent residents regardless where they live, as well as those meeting the substantial presence test - are strongly encouraged to invest in US-domiciled index funds. Non-US investors may prefer to choose funds domiciled elsewhere.
Unless you decided to go with a robo-advisor - in which case you have no choice in the matter - here my personal favorite index ETFs for each asset class:
| Asset class | Representative ETFs (for US investors) |
|---|---|
| US stocks | VTI, SCHB, ITOT |
| Developed market stocks | VEA, SCHF, IXUS |
| Emerging market stocks | VWO, IMEG, SCHE |
| US REIT stocks | VNQ, SCHH, IYR |
| Non-US REIT stocks | VNQI |
What you will find is that this list is closely aligned with Wealthfront's recommendations and they cover good ETFs for other asset classes as well.
Summary
We reviewed what to look for in a broker and index fund, and who the major players in the US and globally are. We identified Vanguard as a particularly attractive broker and index fund issuer and highlighted the best index ETFs for each asset class.
Let me know your comments below!
Go back: Fund structures
