(PUB) Investing 2015

The Independent Adviser for Vanguard Investors

•

February 2015

•

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favor. We don’t put all of our eggs in

500 Index, Total Stock Market Index

or, heaven-forbid,

Total World Stock

Index

, which in some circles is the

ultimate indexer’s dream investment.

Over the past several years, our

allocations to foreign stocks, primarily

through investments in

International

Growth

, have held the

Model

Portfolios

back. In addition, we could

have taken on more interest-rate risk

and earned higher returns from the

bond portions of our portfolios. We

could have held less in

Short-Term

Investment-Grade

, which is my pref-

erence when you’re looking for a port-

folio shock absorber rather than cash

for spending.

While I haven’t heard any complaints

about performance from long-standing

FFSA members, I do know that the

press continues to make a big deal

about beating this index or that index

fund. The truth is that I don’t know

anyone who would seriously own just

an S&P 500 index fund, or for that mat-

ter any all-stock index fund, whether

U.S.-only or globally diversified. And

I’m not building or managing the

Model

Portfolios

in this newsletter to satis-

DOYOU KNOW

where your ETF closed

at year-end? Yes, you probably do,

because you can go to vanguard.com,

log into your account and find the price

right there. Do you know what your

return was? Well, you won’t find it on

your personal account page, but you can

visit vanguard.com’s ETF page to find

the 2014 return for any of Vanguard’s

67 different ETFs. But is the return you

see on Vanguard’s website the return

that you earned on your ETF hold-

ings? Probably not. Did the ETF outper-

form its open-end fund sibling? Again,

there’s a good chance it didn’t.

Let me explain.

The new year is always a good time

to remind those who invest in ETFs

that the performance data they read

and see online, in a newspaper or on

financial news stations is really just an

estimate at best. Even Vanguard esti-

mates total returns, since it doesn’t use

real end-of-day or end-of-year pricing

for its ETFs, but rather a theoretical

price halfway between the bid and ask

prices at the market close. And when

you compare the posted returns for

Vanguard’s ETFs against returns for

its open-end funds, you’ll be surprised

to find that the old-fashioned open-end

funds often outperform.

How do I know? Easy. I own shares

in all of Vanguard’s 67 ETFs. And I

hold all of them through an account

at Vanguard Brokerage, which I guess

you could call “the source,” since it’s

Vanguard’s brokerage unit reporting on

Vanguard’s ETFs. Each month I use the

numbers that Vanguard reports to me

as a shareholder to calculate returns,

including the prices at which Vanguard

says it is reinvesting all my distribu-

tions—and this is what I report to you.

But here’s the thing: What Vanguard

reports on its website for market prices

and market-price-based performance of

its ETFs is simply a fiction.

At year-end, I checked the prices

that Vanguard was reporting on its web-

site and using to calculate total returns

against the ones you’ll find in the

newsletter. Just seven prices matched.

For the other 60, Vanguard’s year-end

price was anywhere from $0.23 higher

than my own to $0.61 lower. So, I fig-

ured I’d log into Vanguard Brokerage

and check the prices in my brokerage

account. Funny, but the prices in my

brokerage account matched the prices

I was using to calculate year-end per-

formance. They had nothing to do with

the prices Vanguard was reporting on

its public-facing webpage.

Naturally, the year-end performance,

based on real prices rather than the pric-

es printed on Vanguard’s public-facing

website, was also very different from

what Vanguard was reporting. How

different? Well, for the year ending in

2014, the differences ranged from over-

stating performance by 26 basis points

(0.26%) to understating performance

by 47 basis points (0.47%).

Now, you might say that a differ-

ence of 0.3% to 0.5% is splitting hairs.

But it’s not, because one of the reasons

investors who love their ETFs cite for

preferring ETFs over index funds is the

lower expense ratios and, supposedly,

better performance.

How would you feel if the return

you think you’re getting because you

read Vanguard’s website isn’t accurate,

and in fact you’d have done better

using a regular index fund? (Believe

me when I tell you that this issue is not

the sole province of Vanguard. As far

as I know, there isn’t an ETF provider

in the country that shows what real

investor returns are.)

Now, you might think that these

errors would disappear over time. Not

so. Looking at three-year, five-year

and, for the few Vanguard ETFs that

have been around long enough, the

10-year returns reported by Vanguard

versus my own real-world calculations,

the differences remain.

Again, this isn’t to say thatVanguard’s

ETFs are bad and others are good, or

that Vanguard is doing something

ETFS

What Price Glory?

fy anyone but you, the above-average

Vanguard investor.

Next month I’ll discuss each holding

in the

Model Portfolios

individually, but

for now I’m sticking with my recom-

mendations in the

Model Portfolios

, and

expect in the coming months you and

I will begin to build our foreign stock

holdings, rather than get rid of them

for underperformance. The pendulum

swings; the tide turns; but you and I can

continue to sail a steady and consistent

course using active managers to achieve

our long-range goals of better returns

with less risk over time.