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2009, there was $10.6 billion invested in Vanguard’s Emerging Market Index fund across all its share classes. In February 2011, assets rose to $57.5 billion and kept climbing until January 2013, when investors had $77.7 billion invested. Strong returns at the start of the recovery and a late flood of money is a recipe for poor investor returns and a large behavior gap. In fact, the investor return story for EmergingMarketsIndexmighthavebeen worse for investors than the table shows. InOctober 2010,Vanguard consolidated itspositions in European Index , Pacific Index and Emerging Markets Index within the TargetRetirement funds into Total International Stock . As a result, these funds had a significant outflow that was driven by Vanguard—not the underlying investors.Thisoutflowskews the investor return upwards as returns after the outflowwere lower thanbefore the change. If we look at only the ETF share classes of these funds, which were not impacted by Vanguard’s decision and actually experienced net inflows in October 2010, we get a clearer picture. The investor return for Emerging

two funds showed the biggest turn- around in five-year returns from the end of February2009 to the endof February 2014, offering the potential for strong returns with some pretty big scares along theway. That type of volatility is difficult for most investors to stickwith and often leads them to buy high and sell low, a recipe for lousy returns. EmergingMarkets Index standsout for being one fundwhere investorsmay havebeenabit tooactivewith their buys and sells, as their average returns were a full 10 percentage points less than the fund’s return. Howdid that happen? Well, like the imaginary hapless investor mentioned earlier, real inves- tors in the fund hadmuchmoremoney invested during lean times than they did in good times. EmergingMarkets Index put up very strong returns in the first two years of the recovery, up 133.8% from the end of February 2009 through the end of February 2011. In the lat- ter three years (ending February 2014) however, Emerging Markets Index lost 9.1%. Unfortunately, investors’ timing was not so good, with far more money being invested during the last three years than the first two. In February

sold$10,000atmid-year, hewouldhave a personal rate of return of 8.6%, more thanone full percentage point above the fund’s 7.3% annual gain. We can apply this analysis to gener- atesomethingcalledan“investor return” for a mutual fund. Some investors may have timed their buys and sells better (or worse) than others, but by consider- ing all of the monthly flows in and out of a fund, we can calculate the return realized collectively by all the investors in the fund. Obviously, your individual return is almost certainly going to vary from the “investor return” if you were addingmoney toorwithdrawingmoney from a fund. But by looking at the overall picture, we can get a sense of just how well or how poorly investors in a particular fund are doingwith their money, rather than focusing exclusively on the fund’s total return. Jeff DeMaso has done that calcula- tion for all of Vanguard’s equity funds (taking into account all of the differ- ent share classes). The table on page 4 shows each fund’s market returns over the five years endingFebruary 2014, as well as the investor returns and the dif- ference between the two. Which brings us back to the origi- nal question: How much of the past five years’ strong stock returns did Vanguard investors capture? On the whole, Vanguard investors did reasonably well, particularly given that it has been a difficult five years to stay the course. The average slippage in performance between the funds and the return realized by investors was only 0.9%. Also, consider that investors in 500 Index realized returns of 22.7% a year while the fund’s returnwas 22.9% per year. That is not much of a gap at all, and speaks to the long-term think- ing thatmanyof the fund’s shareholders obviously adhere to. Clearly though, not all investors cap- tured all of the potential return available to them. Investors in REIT Index and Capital Value failed to capture all of the available returns over the past five years by a wide margin. Investors in REIT Index gave up 7.2% a year, while investors inCapitalValuemissedout on 5.7% of returns per year. Notably, these

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TIMING StudyingProcrastination

I LOVE IT! In a recent study, Vanguard basically confirmedwhat I’ve been recommending to you for years concerning how andwhen to invest for retirement, and they gave it a name. They call it the “procrastination penalty.” In short, the procrastination penalty is the amount ofmoney left on the tablewhen, instead of investing as soon as it is legally allowed, investorswait until the lastminute tomake their IRA contributions, losing out onmore than a year’sworth of returns on thatmoney (actually, 15.5months, which is the time between January 1 andApril 15 of the following year—the period inwhich you canmake a given year’s IRA contribution). Vanguard found thatmore than twice asmuchmoney is contributed to IRAs at the last possibleminute, during the first two weeks of the followingApril, as is invested in the firstmonth that contributions can bemade (January of the prior year). That’s a lot of procrastinating. WhileVanguard’sexample isbasedona relatively lowassumed total returnand runs for 30 years, thedifference in valuesbetween theprompt investor and theprocrastinator addsup to $15,500procrastinationpenalty, or almost 10%of theamount that’sbeen investedover that period. For years I’ve told you to invest your IRAmoney, and your 401(k) money if you can, as early as you can, and not towait. I putmy ownmoneywheremymouth is and usually havemademy IRA contributionwithin the firstweek of the new year. Once it’s invested, I don’t have to think about it, and I certainly can’t spend it, whichmeansmy retirement looks brighter all the time. Followmy lead: Don’t fall subject to the “procrastination penalty,” and you can thankme from the rocker on your porch 30 years down the road.

The Independent Adviser for Vanguard Investors • April 2014 • 5

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