Why we advertise

Posted by on November 25, 2009 @ 9:12 am in Investing

It’s a question we hear from time to time on this blog, as well as through e-mails, letters, and phone calls: “Why does Vanguard advertise?”

It’s a fair question. And believe me, it’s a topic debated vigorously by Vanguard’s leadership team. Given the fact that the expense is ultimately borne by the shareholders in our funds, which in turn are the sole owners of Vanguard, one might well ask, in the words of one client—“Why spend some of my money to attract some other investor?”

Our advertising budget is modest and always has been. But we do spend money to advertise, and here are three reasons why—along with a suggestion for how shareholders like you can help us make advertising obsolete.

Reason 1: Spreading the word

Many investors who should know about Vanguard don’t. And many others may have heard something about us, but don’t understand what makes Vanguard a different kind of investment firm—our client-owned structure; our long-term and consistent investment philosophy; and our focus on providing low-cost, balanced, and diversified investment portfolios. Advertising can help these “Vanguardish” investors find Vanguard.

Indeed, over the years, some of our most loyal clients have criticized us for not doing more to spread the word. They’re almost indignant that Vanguard is “out-shouted” by competitors who advertise far more than we do.

Reason 2: Economies of scale

In the investment business, size matters. As assets rise, some operating costs fall—for example, the fees that mutual funds pay to custodian banks. A larger asset base means that the costs of doing business can be spread more thinly (costs such as computer technology and systems, investment-management fees, accounting, and other services).

As new investors choose Vanguard and entrust their savings to us, they—and our existing clients—benefit from the economies of scale achieved. At Vanguard, the point of attracting new clients is to reduce costs for everyone in the long run. And we’re uniquely positioned to make that happen. That’s because we operate “at cost,” so economies of scale flow right back to fund shareholders in the form of lower expense ratios.

Reason 3: New assets for old

Our clients are far more loyal than the typical mutual fund firm’s shareholders. In fact, redemptions out of Vanguard funds occur at less than half the rate for the industry as a whole. But since the whole point of investing (for most of us, anyway) is to eventually spend the money we’ve invested for retirement or college or another goal, money does flow out of Vanguard as well as in. Advertising helps make up for those “withdrawals.”

Our best form of advertising

Our most effective advertising isn’t really advertising at all. Our primary source of new clients has always been referrals from existing clients—friends telling friends about Vanguard, relatives clueing in each other at family gatherings, finance professors telling their students, and so on. This word of mouth remains absolutely vital. And it’s how traditional advertising could become unnecessary—if enough investors became familiar with Vanguard.

In the meantime, as with other spending decisions at Vanguard, advertising plans are scrutinized for efficiency and effectiveness. Our funds’ low expense ratios mean that the revenue we derive from each dollar invested with us is lower than for most of our competitors. Therefore, we have to be more efficient with our advertising expenditures.

We can’t afford to utter the lament attributed to department store founder John Wanamaker: “Half the money I spend on advertising is wasted. The trouble is, I don’t know which half.”

Note: The link to Wikipedia will open a new browser window. Vanguard accepts no responsibility for content on third-party websites.

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