Download In The Vanguard Core Edition Summer 2012

S U MM ER 2 0 1 2
In The Vanguard
®
A conversation with Vanguard clients
on the global economy
Peter Westaway (left) and
Roger Aliaga-Díaz during a live
webcast on vanguard.com.
Vanguard economists Roger Aliaga-Díaz and Peter Westaway
addressed clients’ questions about the global economy in a live
international webcast on June 21. Clients submitted questions
by e-mail and answered online polling questions about their
own views.
In This Issue
page 3
Is it a different
world when it
comes to investing?
Vanguard CEO Bill McNabb
says no—the classic
principles of investing
still apply.
page 5
Among their top concerns were the outlook
for the U.S. economy and the European
debt crisis.
Mr. Aliaga-Díaz spoke from Vanguard
headquarters in Malvern, Pennsylvania, and
Mr. Westaway spoke from London. The
discussion was moderated by Rebecca Katz,
a principal in Vanguard’s Corporate Strategy
Department. What follows are edited excerpts
(you can see a full replay at vanguard.com).
Risks to the U.S. economy
Ms. Katz: Roger, I thought maybe you could
share Vanguard’s views on the outlook for the
U.S. economy.
Mr. Aliaga-Díaz: Clearly, since the beginning
of the year, we’ve been saying that our view on
the economy is one of cautious optimism, which
basically means positive economic growth but
with reservations.
First of all, we expect the U.S. economy to
keep growing at a pace that is really modest by
historical standards. Since the beginning of the
recovery in 2009, gross domestic product, after
inflation, has been advancing at the pace of
2% per year, which is half of the normal rate
of growth during typical recoveries in the United
States. So, positive growth, but a trend of weak
growth; and that has implications also for the
labor market in terms of slow progress with jobs
and employment rates.
continued on page 12 >
Connect with Vanguard® > vanguard.com > 800-276-7230
A bear market in bonds:
Likely less vicious than
a stock market mauling.
pages 8–9
When it comes to investing
for retirement, Vanguard
research suggests more
saving trumps risk-taking.
page 14
Want to help the children in
your life learn about money?
Tell their teachers about
My Classroom Economy.
CONTENTS
FUND NEWS
Managing Your Wealth
Vanguard closes High-Yield Corporate Fund
page 3
Uncertainty in the markets is nothing new.
CEO Bill McNabb shares four principles of
investing that apply in any market weather.
page 4
With numerous tax breaks set to expire at
year-end, we could face higher taxes in 2013.
But the picture is still far from clear.
page 5
While a bond bear market wouldn’t be any fun,
it likely wouldn’t be as nerve-wracking or
volatile as an equity bear market.
page 6
Estate taxes are scheduled to jump in 2013.
Take time now to review your estate plan—
and watch out for these common mistakes.
Investing Your Money
pages 8–9
If you’re looking to beef up your retirement
account, consider using a powerful lever
that’s already in your tool kit: saving more.
Vanguard High-Yield Corporate Fund was closed to new investors as of May 24,
2012, to curtail strong cash inflows. The fund, which is the industry’s third-largest
high-yield corporate bond fund, had received cash flow totaling $2 billion over the
previous six months. Vanguard determined that limiting new cash flow would protect
the interests of shareholders by preserving the advisor’s ability to manage the fund
effectively. Existing fund shareholders may make additional purchases without limit.
Vanguard will monitor cash flows and take additional steps if needed to limit the size
of the fund, which had $17 billion in net assets at the end of May. ■
Contingent redemption fees eliminated for 33 funds
Earlier this year, Vanguard announced that 33 funds would no longer charge
contingent fees on sales of their shares. These fees had applied to redemptions
that occurred within a specified period after the shares were acquired. The funds’
trustees determined that the fees, which were among several measures in place
to discourage frequent trading, were no longer needed. At the same time, Vanguard
announced that both the purchase and redemption fees for the FTSE All-World
ex-US Small-Cap Index Fund were being reduced from 0.75% to 0.50%. ■
pages 10–11
Mediocre returns have left some investors
searching for more. But performance-chasing
comes with its own set of risks.
AT A GLANCE
At Your Service
page 14
Spread the word about My Classroom Economy
and help kids everywhere learn about dollars
and discipline. (Hey, teachers—it’s free!)
Market Barometer
page 15
A summary of financial markets’ performance.
The Vanguard Viewpoint
page 16
Remembering PRIMECAP’s Howard Schow,
“the greatest investor you’ve never heard of.”
Gus Sauter, Vanguard’s chief investment officer, to retire December 31
George U. “Gus” Sauter, managing director and chief investment officer of Vanguard,
announced in late June that he will retire at the end of 2012. Mr. Sauter, who joined
Vanguard in 1987, played a major role in the company’s rise to leadership in indexing.
He currently directs Vanguard’s global investment management groups, which
oversee aggregate assets of $1.6 trillion of Vanguard’s $2.1 trillion in global assets.
Mortimer J. “Tim” Buckley, managing director, will become chief investment
officer upon Mr. Sauter’s retirement. Mr. Buckley joined Vanguard in 1991 and
has been a member of Vanguard’s senior staff since 2001. He discusses his
investment perspectives and the new role he will assume in an interview at
vanguard.com/buckley. ■
Vanguard’s Bob Auwaerter named to Fixed Income Analysts’ Hall of Fame
On April 19, Bob Auwaerter, principal and head of Vanguard Fixed Income Group,
was named to the Fixed Income Analysts Society’s Hall of Fame.
Mr. Auwaerter has been at Vanguard since 1981. He currently has oversight
management responsibility for all money market and bond portfolios managed by
the Fixed Income Group, with total assets of approximately $650 billion. ■
Note: All investing is subject to risks. Past performance is not a guarantee of future
returns. Investments in bond funds are subject to interest rate, credit, and inflation risk.
Because high-yield bonds are considered speculative, investors should be prepared to
assume a substantially greater level of credit risk than with other types of bonds.
2
In The Vanguard > Summer 2012
MANAGING YOUR WEALTH
Vanguard CEO: There’s no ’new normal’—just the old investing truths
This article is adapted from a guest editorial
written by Chairman and CEO Bill McNabb for
USA Today. It was published on May 11, 2012.
It’s a tough time to be an investor—or so you’ve
been told.
Volatile markets, historically low bond yields,
a shaky global economy, and an uncertain
outlook for the future have prompted some
in the financial community to raise the alarm:
“It’s different this time.” “It’s a new normal.”
“It’s a brave new world.”
It’s a provocative message. It’s compelling.
But I believe it’s wrong.
A brave new world? Not really
I recognize that investors have genuine concerns,
and that the past decade’s volatility has scared
young people, in particular, away from stocks.
According to an October 2011 article in Forbes,
40% of investors in “Generation Y”—between
ages 18 and 30—agree with the statement
“I will never feel comfortable investing in the
stock market.”
Unfortunately, a few of our competitors have
actually fanned the flames of investor anxiety.
Playing on Americans’ understandable fear of
losing money, they’ve created a host of novelty
products and strategies, all but predicting
success—or, at the very least, a modicum
of safety.
If you know anything about Vanguard, you
know that’s not our style. We’re guided today
by precisely the same philosophy that has served
us and our client-owners well for nearly 40 years.
True, some people think messages like “stay the
course” and “tune out the noise” are boring. But
if dedication to enduring and time-tested truths
is boring, then Vanguard is happy to be boring.
(I prefer to think of us as consistent.)
I started working at Vanguard shortly before
the 1987 “Black Monday” crash, and I became
CEO a few weeks before the global downturn
that began in September 2008. I’ve witnessed
breathtaking advances and painful declines. What
I’ve learned along the way is that the markets
have always been volatile and uncertain.
Bill McNabb
Ultimately, though, history and experience make
a powerful case for thinking simply and getting
back to “first principles,” as Frank Lloyd Wright
put it.
Four guiding principles
Whether in architecture or investing, it’s
important to build on a solid foundation. That’s
why we tell investors to consider a balanced
portfolio with diversified exposure to the three
primary asset classes: stocks, bonds, and cash.
Second, save more than you think you’ll need,
particularly where retirement is concerned. How
much? Well, the right answer is different for
everyone, but our experts at the Vanguard Center
for Retirement Research believe that between
12% and 15% of your take-home pay is a good
rule of thumb. If you can’t afford to save that
much right now, start where you can and increase
as your circumstances allow.
Third, keep an eye on costs. Spending less
money on your investment provider can lead to
a higher overall savings rate. And even a 1%
boost in your annual savings may compound
dramatically over time.
The fourth and final principle: Have a plan,
and stick to it. When the markets are unsteady,
investing requires discipline and confidence.
I believe the secret to being a successful investor
is that there really is no secret. It comes down
to making some basic decisions: How to invest.
How much to invest. How much to pay to invest.
And how long to invest.
It doesn’t get much simpler—or more
fundamental—than that. ■
Note: Investments in bond funds are subject to interest rate, credit, and inflation risk.
Connect with Vanguard > vanguard.com > 800-276-7230
3
MANAGING YOUR WEALTH
’Taxmageddon’: Be aware, but don’t panic
Federal Reserve Chairman Ben Bernanke has
called it “a massive fiscal cliff” and the media
have begun to refer to it as “taxmageddon.”
John Kilroy
At the end of 2012, many of the tax breaks
established during President George W. Bush’s
administration are set to expire. In addition, new
Medicare-related taxes for higher income brackets
are scheduled to take effect in 2013. In total, the
changes could amount to the biggest tax increase
in American history. Or maybe not.
There are a number of possible scenarios,
including the chance that Congress could extend
the current tax breaks for a time. But the resolution
likely won’t come for several months.
James Delaplane
Contending with uncertainty
“While there may be some noise around
changes to tax policies this summer, it’s very
unlikely that any real action will come until after
November’s election,” said James Delaplane,
who leads Vanguard’s government relations
office. “The most likely outcome is a short-term
extension of the Bush tax cuts while policymakers
debate broader reforms to the tax code. The
worst-case scenario is that we won’t know what
the rules are for 2013 until after the year has
already begun.”
Changes to the taxation of capital gains and
dividends are likely to be a primary concern
for investors. Generally, investors now pay
a maximum rate of 15% on long-term capital
gains and qualified dividends.
However, if Congress takes no action, the
maximum capital gains tax rate will increase
to 20% in 2013, while the maximum rate on
dividends will jump as high as 39.6%. In addition,
individuals with modified adjusted gross income
above $200,000 (or married joint filers with MAGI
above $250,000) may pay an additional 3.8%
tax on net investment income, such as most
long-term capital gains, interest (excluding
municipal bond interest), and dividends that
exceed those threshold amounts, as a result
of the Affordable Care Act of 2010. Scheduled
increases to all marginal tax rates and the return
of various phaseouts (for personal exemptions
and itemized deductions) may also affect the
amount of tax due.
Understandably, you may feel worried about
all this. But avoid the temptation to make
rash decisions based on speculation about
what might happen, said John Kilroy, a senior
wealth planner in Vanguard Asset Management
Services™. Whether it’s market volatility or
tax-law uncertainty, generally Vanguard believes
your best strategy for coping is to stay focused
on sound financial planning principles, he said.
“If we let emotions dictate, we can end up
making financial decisions we later regret,”
Mr. Kilroy said.
Keep sight of the big picture
Regardless of what happens in Washington,
here are a few timeless rules to keep in mind.
tDon’t let the tax tail wag the dog. Make sure
any tax-related decisions are truly in line with
your long-term financial goals. For example, are
you choosing to recognize capital gains this year
because it’s a good move for your portfolio?
Or simply because you’re speculating that
rates are headed up?
tRecognize that tax planning is a year-round
commitment. It’s important to keep taxes in
mind throughout the year, not just at the end.
That gives you plenty of time to evaluate your
situation and make necessary changes.
tAsk a tax pro. “Everyone’s situation is unique,
so it’s hard to make generalizations,” Mr. Kilroy
said. “If you have questions about your particular
situation, consult a tax professional or a financial
advisor.” ■
Notes: The information provided here is for educational purposes only and isn’t intended to be construed as legal
or tax advice. We recommend that you consult a tax or financial advisor about your individual situation.
Vanguard Asset Management Services are provided by Vanguard National Trust Company, which is a federally
chartered, limited-purpose trust company operated under the supervision of the Office of the Comptroller of the
Currency.
4
In The Vanguard > Summer 2012
MANAGING YOUR WEALTH
A bear market in bonds may not be as grisly as you think
The term “bear market” refers to a sustained
drop in the prices of stocks or bonds. The
similarity ends there, just as there’s a difference
between a panda and a woodland grizzly: Both
can be dangerous if disturbed, but the grizzly
much more so.
“It’s the magnitude of returns that is the key
differentiator,” says Fran Kinniry, a senior
member of Vanguard’s Investment Strategy
Group. “Stocks can earn a lot more than bonds,
but they also can decline more ferociously.”
Another difference is that it’s easier to pinpoint
what typically triggers a bond price decline: an
increase in interest rates.
the bond’s duration (and vice versa). Note that
this rule of thumb assumes an instantaneous
rise for all interest rates, a rare event.
When will rates rise? Nobody knows. “No one
thought that money market funds would be
yielding 0% for so long,” Mr. Kinniry says. “And
Japan has been stuck in a low-rate environment
for two decades.”
Fran Kinniry
Inflation, often a primary driver of increases in
interest rates, has been fairly tame. For the
products Americans buy, prices on average have
actually declined, Mr. Kinniry says, despite “wallet
inflation.” He’s referring to highly visible costs,
such as for groceries and gasoline, that make
inflation seem far worse than it really is.
A long record of limited declines
The difference between the two types of bear
markets is striking.
The worst 12-month span for U.S. bonds since
1926 was the period ended September 30,
1974, when the broad bond market returned
about –14%. The worst period for U.S. stocks,
the 1930s aside, were the 12 months through
February 2009, when they returned about –40%.1
“A bear market in stocks is often defined as a
20% drop in prices,” Mr. Kinniry says. “A bear
market in bonds is simply a period of negative
returns.”
A rule of thumb to help shape expectations
The potential for price declines depends on a
bond’s “duration” or, for bond mutual funds, the
average duration. (For durations of Vanguard bond
funds, visit vanguard.com.)
Duration is a rough gauge of interest rate
sensitivity: For each percentage-point increase in
market rates, a bond’s price should fall over the
next 12 months by a percentage about equal to
Are rate worries beside the point?
Rising interest rates can be viewed as bad news
or good. Bond prices would fall, but holders of
money market funds and short-term bond funds
would see their income go up fairly quickly, and
yields of all bond funds would rise.
If you’re a longer-term bond fund investor, the
immediate pain may eventually subside if your
time horizon matches or exceeds your fund’s
duration. Higher rates will then have time to
work in your favor.
To make that happen, you’ll need to reinvest your
bond fund distributions to participate as your fund
acquires new—and higher-yielding—bonds. Over
time, this process can help offset, or more than
offset, the impact of immediate price declines.
It’s important to remember that, whether
interest rates rise or fall, bonds can serve a vital
function in any balanced portfolio by helping to
cushion the impact of stock volatility. It’s a role
investors should keep in mind no matter what
rates are doing. ■
1 Returns are based on these indexes: For U.S. stocks, the Standard & Poor’s 90 (1926–March 3,1957), the S&P 500 Index (March 4, 1957–1974),
the Wilshire 5000 Index (1975–April 22, 2005), and the MSCI US Broad Market Index thereafter. For U.S. bonds, the S&P High Grade Corporate
Index (1926–1968), the Citigroup High Grade Index (1969–1972), the Lehman Brothers U.S. Long Credit Aa Index (1973–1975), and the Barclays
U.S. Aggregate Bond Index thereafter. The performance of an index is not an exact representation of any particular investment, as you cannot
invest directly in an index.
Note: Investments in bond funds are subject to interest rate, credit, and inflation risk.
Connect with Vanguard > vanguard.com > 800-276-7230
5
MANAGING YOUR WEALTH
Avoid these five common estate planning mistakes
An expected jump in federal estate taxes next
year has prompted many people to take a second
look at their estate plans. If Congress takes no
action, the maximum estate tax rate will jump
from 35% to 55% in 2013.
Alisa Shin
Other taxes may
change next year too—
see page 4.
If you plan to leave your heirs more than
$1 million, it’s certainly a good idea to consult
an estate planning attorney about your best course
of action, said Alisa Shin, a senior wealth planner
with Vanguard Asset Management Services. And
even if your estate will have fewer assets, this
may still be an opportune time to make sure your
estate plan is current and reflects your wishes,
Ms. Shin said.
So now that you’re thinking about it, here are
five common—and potentially costly—mistakes
to watch out for.
Not updating your estate plan.
Experts recommend that you review your estate
plan every three to five years to make sure it
reflects changes in your family and financial
circumstances, as well as changes in the law.
“A lot of people think that after they go to a
lawyer and prepare a will and power of attorney,
they sign it and they’re done,” said Ms. Shin.
“That is not quite correct.”
Look over your will and other estate-related
documents after each birth, death, marriage,
or divorce in the family. Any substantial change
in your finances—whether because of a stock
market decline, a job change, or retirement—
should prompt a checkup. Beneficiary designations in retirement plans, for example, don’t
automatically transfer when you roll over your
401(k), open an IRA, or switch from a traditional
IRA to a Roth IRA.
6
In The Vanguard > Summer 2012
It’s also important for your estate plan to take
into consideration potential future changes to
estate laws. The potential decline in federal
estate tax exemptions from $5 million this year
to $1 million next year could affect your tax
liability and may influence how and when you
distribute your assets.
Ignoring conflicts between your estate plan
and other beneficiary designations.
If your will states that your home and retirement
account go to your current husband, but your
ex-husband’s name is on the deed and your
401(k) plan, there’s a problem. The deed and the
beneficiary designation will likely trump what’s
in your will.
Unless your property titles—for both real estate
and other kinds of assets—and beneficiary
designations are consistent with your trust or
will, they may not be subject to those expressed
wishes.
Not specifying who inherits your estate
and how.
Say, for example, you planned on dividing your
assets equally among your three children. But
your son predeceases you. Unless your will
states that each child’s branch of the family gets
an equal share, or that your son’s share of your
estate should be distributed to his own children,
your two daughters will inherit everything when
you are gone.
Even if your will makes clear that your son’s
children should inherit, you may not want them
to receive the assets outright if they are minors.
Should their shares be placed in a trust? You may
want to discuss this with your family or lawyer.
Writing an inflexible estate plan.
A rigid estate plan cannot adapt to changes in
the law or family circumstances. If your plan was
designed to take advantage of certain tax criteria,
and those laws change, you want to make sure
your heirs can amend it.
“Make sure there is some room for flexibility in
your documents,” said Ms. Shin. “Circumstances
change, and many want their families to be able
to adapt and manage the family assets in the
most optimal way at any given point in time.”
Letting emotions guide your choice of
an executor.
If your beloved eldest son, a high-powered
lawyer, doesn’t get along with his five siblings
and vehemently disagrees with your end-of-life
directives, he may not be the best person to
choose as executor or surrogate health care
decision-maker.
“Your fiduciaries don’t need to be experts in tax
law,” said Ms. Shin. “They just need to be smart
enough to know when to go get help and where
to go to get help.” ■
401(k) plans are becoming more transparent to participants
If you participate in an employer-sponsored
401(k) plan, you’re about to learn more about
what you’re paying to save for retirement and
how your investments are performing.
Under new U.S. Department of Labor regulations
that go into effect this summer, retirement plan
sponsors are required to disclose more fee and
investment information to participants. The goal
is to help people make better-informed choices
about investing the money in their retirement
accounts. The new requirements include
enhanced annual and quarterly disclosures to
plan participants and beneficiaries.
The annual notice. Once a year, participants
must be provided with general plan information,
administrative and individual expense information,
and investment information presented in the
form of a comparative chart.
Sponsors of 403(b) plans also will need to
provide this notice to all eligible participants
and beneficiaries, regardless of whether the
plan currently has one or multiple service
providers. If there are multiple providers, the
regulations require that participants receive
certain investment information from each
provider simultaneously. For example, the
comparative charts from all providers must
be mailed together.
The quarterly notice. Four times a year, a
plan must disclose the dollar amount deducted
from each participant’s account to pay any
administrative and individual expenses.
Participants must receive a description of
fees expressed both as a percentage of an
investment and as the actual dollar cost of a
$1,000 investment. In addition, the regulations
require the disclosure of historical performance
data over one-, five-, and ten-year periods.
For most plans, the initial fee disclosure
notices must be provided by August 30, 2012.
If you’re a plan participant, look for yours in the
mail soon. ■
Connect with Vanguard > vanguard.com > 800-276-7230
7
INVESTING YOUR MONEY
Harnessing the power of ’a penny saved’
Maria Bruno
You can find the
research paper Penny
Saved, Penny Earned at
vanguard.com/research.
Modern portfolio theory—the concepts that
underlie most financial thinking today—would
argue that an aggressive allocation to stocks
should generate higher returns over time than
a comparable holding of lower-risk assets such
as bonds. The flip side, of course, is greater risk
of loss.
During “the lost decade” of 2000–2009, which
left the broad U.S. stock market under water,
that risk came home to roost. The lesson was
especially hard on investors closer to retirement
who had a significant allocation to equities and
were counting on “average” returns from stocks
to reach their goals.
A recent Vanguard study points out that some
of the most reliable and powerful levers in your
retirement toolkit have less to do with modern
portfolio theory than with Benjamin Franklin. The
study, Penny Saved, Penny Earned, illustrates that
investors who increase risk with the objective of
gaining higher returns might actually be less likely
to meet their retirement goals than those who
simply save more, whether by starting earlier or
by saving at a higher rate.
Maria Bruno, a Vanguard investment analyst who
coauthored the study, noted, “The markets over
the past few years have been a reality check for
investors. In saving for retirement, it’s better to
focus on the things you can control—when you
start to save and how much you save—because
that’s going to be the most reliable way to
succeed in meeting your goals.”
Looking at what you can control
The study used the Vanguard Capital Markets
Model® (VCMM) to simulate investment returns
using various assumptions about salaries, asset
allocations, and contributions. One data set from
the study is shown in the accompanying table:
a hypothetical 35-year-old investor planning to
retire at age 65 who puts 12% of an annual salary
into a retirement portfolio with a moderate asset
allocation (50% stocks and 50% bonds).1 After
10,000 simulations based on different potential
scenarios, the investor’s median inflation-adjusted
balance at retirement was about $475,000.
The study then examined the impact that each
of three investment levers—portfolio risk, savings
time horizon, and savings rate—could have on
the investor’s portfolio balance at retirement.
Behind door number 1—a 22% increase
Asset allocation—the portfolio’s balance of
riskier and safer assets—has been proven by
a number of studies to be a powerful driver of
portfolio performance over time.2 Choosing a
more aggressive asset allocation (80% stocks
and 20% bonds) would increase the investor’s
median balance at retirement by 22%.
It’s worth noting, however, that with this
allocation the “worst-case” outcome is a much
lower balance at retirement than the 50%/50%
portfolio produced in its own worst case.
1 More details about the data and assumptions used in the calculations are provided in the paper Penny Saved, Penny Earned, available at
vanguard.com/research.
2 The classic study is “Determinants of Portfolio Performance” by Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower (Financial Analysts
Journal, 1986). Related research includes the Vanguard paper The Asset Allocation Debate: Provocative Questions, Enduring Realities, available
at vanguard.com/research.
8
In The Vanguard > Summer 2012
And door number 3—a 51% increase
Save sooner, save more
As the study shows, saving earlier and saving more
are things you can control. Independently or together,
they are more likely to help you reach your retirement
goals than adding riskier assets in the hope of getting
higher returns.
While investors nearing retirement and facing a shortfall
might be tempted to move more aggressively into stocks
to try to catch up, a less risky option would be to keep
working and keep saving. If you delay retirement by even
a few years, the extra savings coupled with not spending
from the portfolio can make a material difference in
helping to fill the gap.
Door number 2—a 25% increase
As Ben Franklin would have guessed, the power
of compounding has the potential to be the most
effective strategy. By starting to save ten years
sooner, even with the 50%/50% allocation and
the 12% saving rate, our investor would have
garnered 51% more, with a median balance of
almost $720,000 at retirement.
Ben’s adage holds true for costs, too
Another way to save more for retirement is
to make sure your investment costs are low.
All else being equal, if you switch from a
portfolio charging 1.0% to one charging 0.3%,
you’ll effectively increase your savings rate by
0.7%—without even opening your wallet. ■
Adding more savings to the portfolio—in this
case, contributing 15% of an annual salary rather
than 12%—would result in a median balance
25% higher than the initial one, according to the
VCMM simulations.
Looking at the levers: How allocations and saving habits can affect investment outcomes
Median level of
wealth accumulated
by age 65*
Initial retirement plan
▲
▲
▲
&GGFDUPOQPSUGPMJPCBMBODF
BUSFUJSFNFOUGSPNDIBOHJOH
POFJOWFTUNFOUMFWFS
Moderate asset allocation
12% savings rate
Investor begins saving at age 35
t "HHSFTTJWFBTTFUBMMPDBUJPOJOTUFBEPGNPEFSBUF
t TBWJOHTSBUFJOTUFBEPG
t *OWFTUPSCFHJOTTBWJOHBUBHFJOTUFBEPGBHF
$474,461
*Adjusted for inflation, calculated using median historical returns from stocks and bonds.
These results are hypothetical and do not represent any particular mutual fund or other investment.
Source: Vanguard, based on VCMM calculations.
Important: The projections or other information generated by the Vanguard Capital Markets Model (VCMM)
regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual
investment results, and are not guarantees of future results.
The VCMM is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams.
The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international
equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets,
commodities, and certain alternative investment strategies. At the core of the model are estimates of the dynamic statistical relationship between
risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960.
The asset return distributions discussed are drawn from 10,000 VCMM simulations based on market data and other information available as of
December 31, 2010. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may
be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.
Note: There is no guarantee that any particular asset allocation or mix of funds will meet your investment
objectives or provide you with a given level of income. Investments in bonds and bond funds are subject to
interest rate, credit, and inflation risk.
Connect with Vanguard > vanguard.com > 800-276-7230
9
INVESTING YOUR MONEY
By any other name, it’s still performance-chasing—and it’s risky
Christopher Philips
“When in doubt, diversify.” That investment
adage contains a lot of sense. Unfortunately,
even such sage advice can undermine an
investor’s long-term success if it’s used to
justify short-term performance-chasing in the
name of diversification.
“Doubt” has defined the investment environment for more than a decade as the dot-com
collapse, the worst financial crisis since the
Great Depression, and disappearing bond yields
rattled investors’ nerves. Portfolios that were
broadly diversified among stocks and bonds have
held up reasonably well, but for investors who
remember returns from the 1980s and ’90s, the
recent performance hasn’t been strong enough
to dispel doubts about traditional investment
strategies. (A portfolio with 60% of its assets
in the broad U.S. stock market and 40% in the
broad U.S. bond market would have returned
a bit less than 4% a year, on average, from the
end of 1999 to the end of 2011.)1
This doubt has sent some investors in search
of opportunities to boost the returns of their
portfolios.
New horizons, familiar hazards
Where have investors found these presumed
opportunities?
“If you look at cash-flow numbers, the biggest
outflows have been from money market funds
and broad U.S. stock funds, both of which have
performed below expectations over the short
and intermediate term,” said Christopher Philips,
a senior analyst with Vanguard’s Investment
Strategy Group. “And where have we seen the
biggest inflows? Basically, investors have been
adding credit and interest rate risk by moving
from money markets into various bond funds.
At the same time, they’ve been potentially
increasing their volatility and downside risk by
moving into more narrowly focused, riskier
assets that have performed well.”
The trend is clear in the numbers. Vanguard
calculations using Morningstar data show that
investors have pulled $172 billion from U.S.
stock funds and ETFs over the past three years
and are putting money into riskier sector funds
and ETFs ($74 billion in net inflow); emerging
markets equity funds and ETFs ($110 billion in
net inflow); and alternatives such as commodities,
currency, and leveraged products ($142 billion
in net inflow).
Meanwhile, money market funds have seen
$1 trillion exit, while cash has moved into funds
focusing on intermediate-duration bonds (capturing
$250 billion), global bonds ($69 billion), high-yield
bonds ($57 billion), and emerging-market bonds
($35 billion).
1 Past performance is not a guarantee of future results. This return is based on an index weighted 60% Dow Jones
Wilshire 5000 Index and 40% Lehman Brothers U.S. Aggregate Bond Index through May 31, 2005, then 60% MSCI
US Broad Market Index and 40% Barclays U.S. Aggregate Bond Index through December 31, 2009, after which
the Barclays index was replaced by the Barclays U.S. Aggregate Float Adjusted Index. The performance of an
index is not an exact representation of any particular investment, as you cannot invest directly in an index.
10
In The Vanguard > Summer 2012
More diversification can help to lower risk in a
portfolio, and these more narrowly focused funds
may play a part, either by filling in gaps to make
the portfolio more balanced or by representing
assets that tend to move differently from existing
holdings in order to reduce overall volatility. For
example, it may make sense for investors who
have no exposure to, say, emerging markets or
the energy sector to round out their portfolios in
these areas if their investment horizon and risk
tolerance allow.
But the amount of money now flowing into
such narrow segments of the financial markets
suggests that the trend has less to do with
adding diversification than with jumping on the
performance bandwagon.
Remember: The risks you take are real
“I don’t think we can sugarcoat it,” said
Mr. Philips. “If investors are putting significant
amounts of their assets into narrowly focused
funds to boost returns relative to a broadly
diversified portfolio, they need to know that
this can actually mean less diversification, higher
risk, and an increased chance of falling short of
reaching their long-term financial goals.”
Investing more broadly can be a smart move—
but keep in mind that the power of diversification
lies more in reducing risk than in turbo-charging
returns. ■
Net cash flows in equity mutual funds, including ETFs, and alternative investments, 2009–2011
In billions of dollars
U.S. stock funds
(non-sector)
–$172
Sector funds
$74
Emerging-market funds
$110
Alternatives (commodities, currency
and leveraged products, etc.)
–$200
–150
–100
–50
$142
0
50
100
150
200
Sources: Vanguard and Morningstar data.
An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation
or any other government agency. Although a money market fund seeks to preserve the value of your investment
at $1 per share, it is possible to lose money by investing in such a fund.
You must buy and sell ETF shares through a broker, which may incur commissions. ETF shares are not redeemable
directly with the issuing fund other than in Creation Unit aggregations. All ETFs are subject to market volatility.
When buying or selling an ETF, you will pay or receive the current market price, which may be more or less than
net asset value.
Notes: Diversification does not ensure a profit or protect against a loss in a declining market. Stocks and bonds of
companies in emerging markets are generally more risky than stocks of companies in developed countries. Funds
that concentrate on a relatively narrow market sector face the risk of higher share-price volatility.
Connect with Vanguard > vanguard.com > 800-276-7230
11
INVESTING YOUR MONEY
continued from page 1 >
About the economists
Roger Aliaga-Díaz
Peter Westaway
Roger Aliaga-Díaz is a senior economist with Vanguard’s
Investment Strategy Group. His areas of expertise are monetary
policy, international macroeconomics, and finance. Before joining
Vanguard in 2007, Mr. Aliaga-Díaz was a visiting professor of
macroeconomics at Drexel University’s LeBow College of Business.
He earned a B.A. in economics from Universidad Nacional de
Córdoba, Argentina, and a Ph.D. in economics from North Carolina
State University.
Peter Westaway is Vanguard Asset Management’s chief economist
for Europe. Based in London, he provides Vanguard’s perspective on
European economic issues and their investment strategy implications.
Mr. Westaway was previously chief economist–Europe for Nomura
International and a senior official with the Bank of England. He holds
a Ph.D. in economics from the University of Cambridge, which also
awarded him a master’s degree, and he has an undergraduate degree
in mathematics and economics from the University of York.
And the second reservation relative to this
cautious optimistic outlook is related to the
very same risks that we are polling our audience
about. Those include concerns about federal
budget deficits and the European debt crisis.
Even if the worst-case scenario for these risks
doesn’t actually happen, all of the uncertainties
may already be impacting businesses’ decisions
in terms of hiring, in terms of capital spending,
and even consumers’ spending plans, too.
Ms. Katz: We have our poll results about what
the audience thought would be the biggest risk
to the U.S. economy. It looks like the majority
of folks, 57.5%, said federal budget deficits.
So we’re really concerned about our own
debt issues.
Mr. Aliaga-Díaz: And there are two dimensions
to this risk. One is long-term, the sustainability
of U.S. debt on a long-term basis. And there is
also another dimension—which is really short-
12
In The Vanguard > Summer 2012
term, at the end of this year—around the
so-called fiscal cliff. Unless Congress does
something to avoid it, there are going to be
massive, automatic tax increases and reductions
in federal spending. So it’s a double risk that
clearly people are concerned with.
Will the Eurozone survive?
Ms. Katz: Now we have a ton of questions about
Greece, and we’re going to dive into those, but
first let’s see what our audience thought about
the future of the Eurozone.
We asked, “Will the Eurozone survive?” Sixtytwo percent of our audience said yes, but only
with major reforms, including a possible Greek
exit. Does that result surprise you, or do you
think that’s the most likely scenario, Peter?
Mr. Westaway: I do think the Eurozone will
survive, but I think major reforms are necessary.
As it happens, I think Greece will still just about
stay inside the monetary union, but I don’t think
that’s a certainty at all anymore. I mean, if you’d
have asked me a year ago, I’d have said the
chance of any country leaving was pretty small.
Now, it’s almost a coin toss whether Greece
leaves or not. And I think the reason for that is
simply, if they were to leave, it would change
the nature of the monetary union. It suddenly
becomes a sort of reversible arrangement that
people can check in and out of. And that really
changes matters for other countries like Spain
and Italy. And that’s why we’re getting so
much market pressure at the moment on
those countries.
Ms. Katz: Our next question pivots from this
discussion. It’s from Boris in San Francisco,
California, and he asks, “What’s the probability
of the euro currency failing and countries
returning to national currencies?”
Mr. Westaway: If you ask me to put a
probability on the euro unraveling, I’d say it’s
a relatively small number but a lot higher than
I used to think. I’d say 10%, 15%. I’d say the
chance of one country, like Greece, leaving the
euro is a slightly higher probability, perhaps 40%,
35%, something like that. So the numbers are
much more worrying than they used to be. But
I still think, in the end, policymakers in Europe
know how difficult it would be if countries did
start peeling off and, worse, if the euro area did
unravel. So that’s why I think the policy response
in Europe is going to be whatever is necessary
to stop that from happening.
Are central bankers risking
runaway inflation?
Several clients’ questions focused on the
extraordinary steps the U.S. Federal Reserve
and other central banks throughout the world
have taken to stimulate economic growth.
At various times in recent years, central
banks have pursued a policy of “quantitative
easing,” or “QE,” in which the banks buy
financial assets to inject money into the
economy. Critics contend that these moves
could spur runaway inflation. Some observers
have even speculated that central banks may
be purposely courting high inflation because
it would, in effect, make it cheaper for countries
to pay their debts.
Mr. Westaway: As a former Bank of England
official myself, this was the sort of question
that was asked a lot when the Bank of England
first started rolling out QE. And I think the key
point is that the purpose of QE is to prevent
inflation from being too low or from straying
into deflation territory. So the whole purpose
of it is to generate enough inflation to offset the
deflationary pressures. Of course, if you get it
wrong, you’ll generate too much inflation, but
that’s not the purpose. Some people think there’s
a conspiracy—that this is a backdoor way of
inflating away the debt. But that’s simply not
the case. The risk that inflation is going to get
out of hand because of loose monetary policy
is, I think, sometimes overplayed by market
participants.
Mr. Aliaga-Díaz: And I’d like to [speak to]
this idea that it’s somehow convenient for
the government to inflate its way out of debt.
That may have worked in the past, especially
after the huge amounts of debt in World War II,
but it may not work this time around. Even if the
government managed to increase inflation, that
wouldn’t decrease borrowing, because much
of the government spending is actually inflationlinked. If you started to think in terms of Social
Security payments, Medicare payments, even
the salary paid to a schoolteacher, everything is
linked to inflation. So the more the government
inflates, the more borrowing it needs to do to
fund the spending. ■
Connect with Vanguard > vanguard.com > 800-276-7230
13
AT YOUR SERVICE
Tell a teacher! Here’s a free, fun program on dollars and sense
At myclassroom
economy.org, teachers
can download materials
for free and see how the
program links to national
curriculum standards.
Megan Kauffman’s fourth graders at Stephan
A. Decatur Elementary School in Northeast
Philadelphia rent their desks, maintain bank
logs, earn salaries for performing classroom
jobs, pay bills, and spend some of their
earnings at classroom auctions.
Students across the country, at all grade levels,
are doing the same. And there’s room for many
more to get involved—using materials that
teachers can get online for free. Vanguard hopes
you’ll spread the word to all the teachers and
educators you know.
It’s all part of My Classroom Economy,
a financial education program created at
Vanguard and based on concepts by awardwinning teacher Rafe Esquith, the author of
There Are No Shortcuts, Teach Like Your Hair’s
on Fire, and Lighting Their Fires. By simulating
an actual economy, the program provides realworld lessons that can last a lifetime, and it
does so in a way kids enjoy.
“It’s wonderful,” Ms. Kauffman said of the
program. “It’s unbelievable what these kids
know now about money.”
Paying off the mortgage
My Classroom Economy caters to students from
kindergarten through 12th grade. The program’s
concepts become more sophisticated as students
progress in school. When they reach the upper
grades, students can open a simulated retirement
account and invest their classroom “dollars” in a
personal asset mix of stocks and bonds.
Mr. Esquith has had years of experience and
success reaching his fifth-graders at Hobart
Elementary School in Los Angeles. Through his
books and media coverage, his ideas have spread
to schools throughout the country. Shannon
Nutter-Wiersbitzky, a Vanguard manager, learned
about the program when her fourth-grade son,
Ryan, wondered aloud when he’d be able to pay
off his “mortgage.”
14
In The Vanguard > Summer 2012
“It was a simple question at the dinner table,”
she said. “The program had made enough of an
impact that he was talking about it at home.”
Intrigued and impressed, Ms. Nutter-Wiersbitzky
contacted Ryan’s teacher, and he introduced her
to Mr. Esquith’s concepts and books. Through
Ms. Nutter-Wiersbitzky, Vanguard came on board
and a partnership with Mr. Esquith was formed.
About 40 Vanguard crew members are involved
in the project.
“We want to make it accessible to all teachers,”
Ms. Nutter-Wiersbitzky said. “One of the special
things about the program is it allows kids to
repeat and practice skills they otherwise wouldn’t
get the chance to practice.”
Spreading the word
There’s a real need for financial education in
the nation’s schools. Nearly half of adults grade
their knowledge of personal finance as a C, D,
or F, according to the 2012 Consumer Financial
Literacy Study.
A broader lesson of My Classroom Economy—
one that kids can take into adulthood—is that
there’s a great benefit to delaying gratification.
Ms. Kauffman’s class is grasping and enjoying all
that My Classroom Economy has to offer. Plans
are under way to roll it out to the entire school.
“I keep telling all my friends to tell their friends,”
Ms. Kauffman said. ■
MARKET BAROMETER
Second quarter 2012
Total Returns: Periods ended June 30, 2012
Annualized
An anxious three months
After an ebullient first quarter, U.S. stocks faltered
in the second. The broad market returned –3.21%
as measured by the Dow Jones U.S. Total Market
Index. International stocks pulled back more
sharply, reflecting investors’ apprehension about
the Eurozone’s debt crisis.
Many sought shelter in bonds. The taxable and
municipal U.S. bond markets delivered solid
second-quarter returns, as investors bid up prices
and drove down yields. The returns of 3-month
U.S. Treasury bills hovered near 0%, consistent
with the Federal Reserve’s target for the shortestterm interest rates.
Three
months
One
year
Three
years
Five
years
Ten
years
Dow Jones U.S. Total Stock Market Index
–3.21%
3.78%
16.84%
0.63%
6.16%
MSCI All Country World Index ex USA
(International)
–7.61
Stocks
The wait is over. As global turmoil and
Federal Reserve policy have driven bond yields
to historical lows, the old pecking order has
been restored. At the end of the second quarter,
the S&P 500 Index yielded 2.08% based on its
trailing 12-month dividends, exceeding all but
the longest-term Treasury yields. The 10-year
Treasury note yielded 1.62%.
Operating P/E ratios drooped
At the end of the second quarter, the S&P 500
Index’s price/earnings (P/E) ratio was about
14 based on operating earnings, which exclude
extraordinary items and certain other items.
Over the past 15 years, a period that includes
the late-1990s tech bubble and the collapse in
corporate profits in 2008–2009, the average
operating P/E has been about 20. ■
6.97
–4.62
6.74
Bonds
Barclays U.S. Aggregate Bond Index
(Broad taxable market)
2.06%
7.47%
6.93%
6.79%
5.63%
Barclays Municipal Bond Index
(Broad tax-exempt market)
1.88
9.90
7.62
5.95
5.28
Citigroup 3-Month U.S. Treasury Bill Index
0.02
0.04
0.08
0.87
1.77
The performance of an index is not an exact representation of any particular investment, as you cannot invest
directly in an index.
Bond yields dip below stock yields
Back to the future?
16%
12
Yield
“In 1958, I’d been in the business for seven
years when, for the first time in history, bonds
yielded more than stocks,” the late Peter
Bernstein explained to SmartMoney magazine
in 2008. “My associates said, ‘It’s an anomaly,
don’t worry, it will be reversed.’ It’s 50 years
later, and I’m still waiting.”1
–14.57
8
4
0
Jan.
1955
Jan.
1965
Jan.
1975
Jan.
1985
Jan.
1995
Jan.
2005
S&P 500 Index dividend yield
Yield of 10-year Treasury
Sources: Standard & Poor’s and Vanguard.
S&P 500 operating price/earnings ratio
30
30
28
15-year mean P/E
Operating: 20.08
28
26
26
24
24
22
22
20
20
18
18
16
16
14
14
12
12
90 92 94 96 98 00 02 04 06 08 10
12
Last observation: June 30, 2012. Shaded areas indicate U.S. recessions.
Sources: Standard & Poor’s; data are from Crandall, Pierce & Company.
1 The article is available at smartmoney.com/invest/markets/bullet-proof-your-portfolio-23867/.
Connect with Vanguard > vanguard.com > 800-276-7230
15
THE VANGUARD VIEWPOINT
The enduring legacy of PRIMECAP’s Howard Schow
When Howard B. Schow died in April at
age 84, the financial press called him “an
unsung investing legend” and even “the
greatest investor you’ve never heard of.”
Of course, we at Vanguard had more than
heard of Mr. Schow—we knew him well
and were greatly saddened by his passing.
Vanguard’s relationship with Mr. Schow
dated back nearly 30 years to his co-founding
of PRIMECAP Management Company and
the launch of Vanguard PRIMECAP Fund.
Over time, that relationship expanded, and
ultimately Mr. Schow managed portions of
four other Vanguard funds: PRIMECAP Core
Fund, Capital Opportunity Fund, the Vanguard
Variable Insurance Fund’s Capital Growth
Portfolio, and the U.S. Opportunities Fund
(which is available to non-U.S. investors).
Vanguard is often linked publicly with index
investing, but we also have a rich history
of active investment management that dates
to 1929, when the Wellington™ Fund was
launched. Mr. Schow and his colleagues at
PRIMECAP Management have made a
distinguished contribution to that tradition.
From its inception on November 1, 1984,
through March 31, 2012, the PRIMECAP
Fund had an average annual return of
13.08%; the S&P 500 Index’s average annual
return was 10.72% during the same period.
Mr. Schow’s strong record was based on a
profound commitment to long-term investing—
an enduring lesson for all investors. He and
his colleagues sought out opportunities that
would bear fruit over years, and then pursued
those opportunities with discipline. Their
patience was often rewarded, notably in the
areas of technology and health care. We
will always be grateful to Mr. Schow for his
stewardship of client assets.
Aside from his investment record, those
at Vanguard who worked with Mr. Schow
valued him greatly as a person. “Personally,
I learned a great deal from Howard, and I
will miss his perspective, his candor, and
his balance of optimism and pragmatism,”
Vanguard CEO Bill McNabb wrote in
PRIMECAP Fund’s most recent report to
shareholders.
One of Mr. Schow’s lasting accomplishments
is the deep and talented team of portfolio
managers he helped to build at PRIMECAP
Management. Noting that his co-managers
have assumed responsibility for the assets
he managed, Mr. McNabb said: “I am
confident that they will continue to pursue
the standards of excellence that PRIMECAP
Management has become known for over
the decades.” ■
Average annual total returns for periods
ended 3/31/2012
PRIMECAP Fund
(Investor Shares)
One
year
Five
years
Since
Ten inception
years (11/1/1984)
2.95%
4.35%
6.24%
13.08%
The performance data shown represent past
results. Investment returns and principal value
will fluctuate, so investors’ shares, when sold,
may be worth more or less than their original cost.
Current performance may be lower or higher than
the performance data cited. For performance data
current to the most recent month-end, visit our
website at vanguard.com/performance.
Comments? Topics of interest? Write to us at [email protected].
For more information on Vanguard funds, visit vanguard.com, or call 800-276-7230, to obtain a prospectus.
Visit our website, call 800-276-7230, or contact your broker to obtain a prospectus for Vanguard ETF ®
Shares. Investment objectives, risks, charges, expenses, and other important information are contained
in the prospectus; read and consider it carefully before investing.
Vanguard Brokerage Services is a division of Vanguard Marketing Corporation, Member FINRA.
For information about Vanguard
funds, Vanguard Brokerage Services®,
or your account, call us toll-free
Monday through Friday from 8 a.m.
to 10 p.m. and on Saturday from
9 a.m. to 4 p.m., Eastern time:
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For automated fund and account
information 24 hours a day, 7 days
a week, call Vanguard Tele-Account®:
800-662-6273.
Send your written comments to:
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P.O. Box 2600
Valley Forge, PA 19482-2600
Overnight mailing address:
Vanguard
455 Devon Park Drive
Wayne, PA 19087-1815
S&P ®, S&P 500 ®, and 500 ® are
registered trademarks of Standard
& Poor’s Financial Services LLC
(“S&P”) and have been licensed
for use by The Vanguard Group, Inc.
The Vanguard mutual funds are not
sponsored, endorsed, sold, or
promoted by S&P or its Affiliates,
and S&P and its Affiliates make no
representation, warranty, or condition
regarding the advisability of buying,
selling, or holding units/shares in
the funds.
The funds or securities referred to
herein are not sponsored, endorsed,
or promoted by MSCI, and MSCI
bears no liability with respect to
any such funds or securities. The
prospectus or the Statement of
Additional Information contains a
more detailed description of the
limited relationship MSCI has with
Vanguard and any related funds.
Morningstar data © 2012
Morningstar, Inc. All rights reserved.
The information contained herein:
(1) is proprietary to Morningstar
and/or its content providers; (2) may
not be copied or distributed; and
(3) is not warranted to be accurate,
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Morningstar nor its content providers
are responsible for any damages or
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information.
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© 2012 The Vanguard Group, Inc.
All rights reserved. Vanguard Marketing
Corporation, Distributor.
ITVC 082012