by Archie M. Richards, Jr., CFP^®
December 22, 2003

David earns about $125,000 a year. He has $200,000 in IRAs and other investments, partly in Vanguard index funds. Having recently come into an additional $800,000, he asks whether it's safe to put the new money with Vanguard. What if the company went belly up?

Vanguard is safe, David. Here's why:

• The Vanguard Group is owned by its mutual funds and therefore owned indirectly by the fund shareholders. Owners and clients are the same people.

• Each Vanguard mutual fund is a separate corporation that stands on its own. A problem in one fund affects no other. Vanguard manages only its index funds. Actively-managed funds are farmed out to other investment advisors, with performances carefully monitored.

• If Vanguard went busted (I can't imaging this happening), the independent trustees of each fund would immediately secure consistent management for shareholders.

• Under federal law, all mutual funds must place their investment assets with third-party custodians for safekeeping. Vanguard selects large, well-capitalized national banks, all of which carry ample insurance coverage to cover potential losses of cash or securities.

• Vanguard has put in place extensive contingency plans and backup systems, all tested frequently to ensure continued operations in the event of disaster.

• Vanguard carries substantial insurance to make clients whole in the event of illegal acts, such as fraudulent check writing or inappropriate redemptions. Since the company's 1974 founding, payments from these policies have never been necessary.

• Neither Vanguard nor any of its funds has engaged in wrongdoings that other fund companies have recently been accused of.

David also asks whether he should acquire an annuity or just "invest the money in the market and let it grow?"

Vanguard offers annuity policies. But the costs are higher, and all earnings are taxed when distributed at high ordinary income rates. I would just put the money in the market.

Finally, David asks whether he should consider an investment adviser.

Vanguard is an investment adviser. I like its structure and the low costs of its index funds. Here's why the costs are low: In my columns dated 6/30/03 and 11/10/03 (see www.archierichards.com), I recommend various Vanguard index funds, all of which happen to track indexes owned by Morgan Stanley. The U.S. Small Cap Value Index, for example, is a hypothetical portfolio of approximately 930 value stocks of smaller U.S. companies chosen by Morgan Stanley. To replicate this index for its U.S. Small Cap Value Index Fund, Vanguard acquires all 930 stocks in the proportions called for by Morgan Stanley. The index stocks are changed infrequently by Morgan Stanley, and Vanguard therefore buys and sells infrequently. With no stock research, Vanguard's annual operating costs are only 0.27 percent. With relatively few buys and sells, transaction costs are also low. In investing, costs count.

In my columns, I've recommended particular index funds and the proportions for each. My portfolio is highly diversified and involves rebalancing every 13 months. The suggestions may be wrong, but they're based on proven portfolio theory, and you get them for nothing.

An investment advisor who manages your money individually would probably skim at least 1 percent off of your investment assets each year. His recommendations might be better than mine, but even if he uses Vanguard funds, he'd have to beat my suggestions by the amount of his fee just to come out even on a net basis. With higher-cost mutual funds, he'd have bigger hurdles to overcome.

Vanguard provides financial plans for $500. With at least $250,000 of new money, the plan costs nothing. If you adopt my recommendations but need help with the rebalancing, perhaps a financial planner can assist.

Some people use individually managed investment advisors because they like to feel special. Rich people - a group you're now joining - like to feel very special. In purchasing cars, houses, and other tangible products, be as unique as you please. But Mr. Market won't treat you specially. If you try to outdo him, your risks rise substantially. Just acquire a broad selection of index funds, rebalance every 13 months, and accept what the market gives you. In the long run, you'll come out just fine.