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Vanguard has just supplanted Fidelity as America's biggest mutual fund company, with $1.3 trillion in assets. Best of all, it's done so the right way: focusing on index funds and offering low fees.

Index matters
Vanguard's founder, John Bogle, is known as the father of index funds. Over the past few decades, investors have shifted more and more of their dollars away from actively managed mutual funds, and toward these cheaper, simpler, lower-maintenance investments. Between the beginning of 2008 and this past August, Morningstar estimates that stock-index funds took in $113 billion, while managed stock funds lost $301 billion.

That exodus likely owes to investors' increasing awareness that over most long periods, stock index funds, which simply mimic the holdings of a broad stock market index, have outperformed managed funds, in which professionals actively study, buy, and sell stocks. (In fairness, managed funds have bucked the trend and outperformed in the past decade.)

We at the Fool have long recommended index funds. So has none other than Warren Buffett, noting in his 1993 letter to Berkshire Hathaway shareholders: "By periodically investing in an index fund, for example, the [inexpert] investor can actually outperform most investment professionals." And in 1996: "Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees." 

Fee matters
Higher expenses are one of the reasons that so many managed mutual funds underperform index funds. According to data from the folks at Lipper, managed stock funds charge an average annual fee of 0.95% (dollar-weighted), while stock index funds average about 0.29%. Vanguard's flagship S&P 500 index fund charges just 0.18%, while Fidelity's Spartan 500 charges 0.10% (though the latter has a higher minimum investment amount).

Seemingly small differences in fees can make a big difference over the long haul. Over 20 years of 10% annual growth, an active fund charging 1.2% per year will turn $10,000 into $54,000. But with the same initial investment, return, and time frame, an index fund charging 0.2% will amount to $65,000.

Fund fees matter, and managed funds' higher fees put them at a disadvantage from the get-go.

Winners abound
While it's interesting that Vanguard has surpassed Fidelity, it won't change our lives. What really matters to you and me are the specific characteristics and fees of any fund we're looking at. Below are some exchange-traded funds (ETFs), based on broad-market indexes, with particularly low fees. I'm listing ETFs because they don't have minimum investment amounts, like most mutual funds.

Interestingly, Vanguard has embraced exchange-traded funds (ETFs), while Fidelity has yet to do so. Vanguard offers 62 ETFs now and recently held more than $100 billion in ETF assets. And true to its tradition, its ETFs sport some very low fees.


Index Tracked

Expense Ratio

Vanguard S&P 500 ETF S&P 500 0.06%
SPDR S&P 500 (NYSE: SPY  ) S&P 500 0.09%
iShares S&P 500 (NYSE: IVV  ) S&P 500 0.09%
Vanguard Total Stock Market ETF (NYSE: VTI  ) Total U.S. stock market 0.07%
SPDR Dow Jones Total Market Total U.S. stock market 0.20%
Vanguard FTSE All-World ex-US ETF (NYSE: VEU  ) Total world stock market, excluding the U.S. 0.25%
Vanguard Total World Stock Index ETF (NYSE: VT  ) Total world stock market 0.30%

Data: Morningstar.

Vanguard's rise suggests that investors who don't have the time to find compelling stock bargains on their own are still making smart choices with their long-term investments. Consider joining them by adding a few index funds to your own portfolio. If nothing else, these securities can't underperform the market -- because, after all, they are the market.

If you want to pick stocks on your own, look at what the great investors are buying.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Longtime Fool contributor Selena Maranjian owns shares of Berkshire Hathaway, which is a Motley Fool Inside Value selection and a Motley Fool Stock Advisor recommendation. The Fool also owns shares of Berkshire Hathaway. Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.

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