Schwab could be ETF investors’ new Vanguard

Like-minded rivals battle to be king of low costs

Vanguard Group has become the world’s largest fund company, with more than $1.7 trillion under management. Founder John Bogle discovered that indexing markets outperformed active managers after fees, and the firm has become a champion for low-cost investment products.

Now there’s another formidable player in this penny-a-point game.

Charles Schwab Corp. SCHW +0.29% has aggressively entered the exchange-traded fund market with products that compete with both Vanguard and BlackRock Inc.’sBLK -0.10% iShares lineup.

Schwab has ETFs covering all of the major asset classes, including Schwab U.S. Broad Market ETF SCHB +0.15% to compete with Vanguard Total Stock Market ETFVTI +0.16% .

Schwab’s four bond ETFs include Schwab US Aggregate Bond ETF SCHZ -0.04% , which competes with Vanguard Total Bond Market ETF BND -0.01% and iShares Barclays Aggregate Bond Fund AGG +0.02% . It also offers emerging markets and foreign developed-country ETFs, such as Schwab Emerging Markets Equity ETF SCHE +0.71% that competes with Vanguard MSCI Emerging Markets ETFVWO +0.64% and iShares Inc. MSCI Emerging Markets Index Fund EEM +0.67% .

Rebel, rebel

But here’s the clincher: Schwab is pricing several of its domestic-stock ETFs lower than Vanguard.

What’s the deal? When other ETF sponsors are looking for niches like a double-leveraged short on gold, why would Schwab go after the biggest and most entrenched products? Sure, Schwab has tremendous reach with millions of investors, but anyone can buy any ETF at Schwab because they trade like stocks.

Charles Schwab started his firm around the same time as Bogle started Vanguard. Leveraging new regulation in the 1970’s, Schwab launched the first discount brokerage and drove down broker commissions.

Once a rebel, always a rebel. Since Schwab took back control of his namesake firm, it seems that he sees an opportunity to disrupt the retirement industry, particularly 401(k)s. ETFs will enable him to do so and most important, leave a positive legacy for Schwab.

For Schwab, ETFs are not “funds” but rather tools for building precisely allocated, sophisticated retirement portfolios more akin to how endowments and pensions invest. Unlike the mutual fund world, where one active manager is pitted against another like jockeys in a horse race, ETFs are tools for getting market exposure. Markets are the ingredients of successful diversification — the more you have, the better.

U.S. stocks and counterparts in other developed countries tend to move independently from each other. So allocating money to both markets creates instant diversification. Emerging markets also move to the beat of a different drummer. Bonds and real estate are further afield from stocks, so adding these markets provides excellent diversification. Every year, some market wins and others lose and no expert can predict the future. So own them all! ETFs enable an investor to do so.

With a proper mix of ETFs tracking many markets, it’s possible for any investor with any amount of savings to build a low-cost, diversified portfolio including shares of U.S. companies, stocks in foreign developed countries and emerging markets, U.S. government bonds, real estate, and commodities. This wasn’t possible just a few years ago.

Schwab’s plan is to become a dominant player the 401(k) market, leveraging its ETFs and its broad platform. Because new Department of Labor laws require fee disclosure, corporations are going to wake up and realize that they are allowing their employees to be ripped off on a grand scale by many traditional 401(k) plans.

Enter Schwab with low fee 401(k) plans using ETFs. This is going to be highly disruptive. Today’s 401(k) platforms only accommodate mutual funds and that’s why employers can’t offer low cost ETFs to employees. Schwab’s new “Index Advantage” retirement plan will leverage the new changes in fee disclosure laws, its ETF roster, and a new 401(k) platform that accommodates them.

In this way, Charles Schwab, like Bogle, will cement his legacy as an advocate for working Americans and an investment industry leader who helped keep billions of dollars in people’s pockets.