Vanguard and full-service brokerage funds

Vanguard vs. Fidelity

After Fidelity, Vanguard is America's second largest mutual fund family, with nearly 100 mutual funds. In many ways Vanguard is the exact opposite of Fidelity.

Whereas Fidelity likes active trading and isn't afraid of risk, Vanguard prefers passive index investing and is generally conservative. While Fidelity excels at stocks but lags in bonds, Vanguard is great in bonds but doesn't have a great stock picking reputation.

Fidelity also advertises heavily and sells its load and no-load funds through any channel it can find. Vanguard advertises little and offers only no-loads. And if you want to invest with Vanguard, get ready to pick up the phone and lick some stamps because it only sells its funds directly.

Vanguard will save you money

But if you like to save money and believe that it's tough to beat the market, Vanguard is the place to be.

Vanguard introduced the first stock index fund modeled after the Standard & Poors 500 index in 1976, and this fund is the benchmark for all other stock funds. Since its inception, the fund has outperformed 75 percent of other actively managed stock funds, partly because it has very low management fees of only 0.2 percent, compared with about 1.4 percent for the average stock fund.

This stock index fund is also one of the largest stock funds around, showing that a lot of people believe in indexing.

Although you may never have heard of Vanguard, this is probably no accident. To keep its expenses low, Vanguard advertises little. Although Vanguard may be little known to newcomers, you should look into Vanguard if you're not afraid to manage your own money.

Merrill Lynch

Unlike Vanguard, Merrill Lynch is a well known name. Merrill Lynch is the sixth largest provider of mutual funds.

Merrill Lynch, of course, is also one of the old-line, so-called full-service brokers. It provides a wide range of services to a variety of customers. You can buy individual stocks, bonds and mutual funds from full-service brokers.

But these brokerages have investment bank divisions which make a great deal of money by serving corporations. Whenever a company issues stocks or bonds, they almost always turn to a company like Merrill Lynch.

Potential conflicts of interest with investment banks

This can cause a conflict of interest for the mutual funds offered by Merrill Lynch and its brethren like Prudential, Smith Barney, Dean Witter and Oppenheimer.

The two largest mutual fund families, Fidelity and Vanguard, are first and foremost mutual fund companies. Fidelity and Vanguard both offer discount brokerage services, but these two companies owe their success to serving their mutual fund customers.

When it comes to things like investing in new stock issues, funds managed by investment banks like Merrill Lynch may be torn between getting the best deal for it's corporate customers, or serving it's individual mutual fund investors.

Perhaps because of conflicts like this, mutual funds offered by Merrill Lynch and it's cousins are generally poor performers. They're often expensive and almost always have high front or back-end loads.

For example, as I was reviewing mutual fund families in preparation for this tape, I was shocked at some of the expenses that companies like Oppenheimer were charging for their mediocre stock and bond funds. Unless you have a good reason, I'd recommend you stay away from a brokerage firm's in-house funds.