(PUB) Investing 2015

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12 • Fund Family Shareholder Association
FIGHT OR FLIGHT? These two basic
responses to a perceived threat served
our ancestors well, but in today’s modern
world most people do not face life-or-
death situations in their day-to-day that
engages their fight-or-flight instincts.
Except, of course, when it comes to
the stock market, where (at least accord-
ing to many commentators) investors
are constantly fleeing to safety, or sell-
ing first and asking questions later.
The fight response might be more
appropriate, though. Consider that the
U.S. stock market has been in a bull
market for more than six years despite
myriad “scares” that raised the hair on
Wall Street’s neck. Here is an incomplete
list of perceived threats that were said to
have forced some investors to flee:
n Affordable Care Act—passage would
kill the health sector
n Arab Spring—Middle East chaos
n China slowing—global demand
would suffer
n Comparisons with 1929—the charts
say “Depression”
n Cyberattacks—corporations aren’t safe
n Cyprus—bank defaults would lead to
global disaster
n Ebola—a global pandemic
n Flash Crash—the markets are unsafe
n Grexit, Parts 1 and 2—the demise of
the EU and the euro
n ISIS—a world in chaos
n Libya—more Middle East chaos
n Quantitative Easing—leading to
hyperinflation
n Sequestration—the U.S. government
in chaos
n Tapering—without stimulus, the
economy would crater
n Ukraine, Crimea and Russia—chaos
and war-mongering
n U.S. debt rating downgrade— the U.S.
in trouble
n U.S. government shutdown—the U.S.
in trouble
Clearly, the list of reasons to avoid
the stock market is ever-expanding, and
yet investors have been much better
off staying in the markets. Flying to
safety is just another way of saying that
investors are trying to time the markets:
Something has happened, and they are
trying to get out of the market before
it gets worse, with the idea of getting
back in after the danger is gone. Only it
rarely works that way. As the list above
shows, predicting what will spark the
next bear market is not an easy task. And
don’t forget that to be successful in this
endeavor, you need to not only avoid the
danger but get back into the market after.
Still, the flight-to-safety instinct is
a strong one, and there will be another
bear market, so let’s discuss funds
investors commonly turn to for safe-
ty—and show why you’ll be better off
moving away from the all-or-nothing
mindset of fight or flight.
Shock-Absorbing Funds
For those seeking protection from
falling stock prices, U.S. Treasurys
remain the flight-to-safety asset of
choice, and long-maturity Treasurys
provide the most bang for your buck.
Consider that Extended Duration
Treasury ETF gained 55.0% in
2008 as 500 Index lost 37.0%. Or
take the third quarter of 2011, when
500 Index lost 13.9%, and Extended
Duration Treasury ETF gained a whop-
ping 52.7%. That’s certainly a lot of
return to offset declining stock prices,
but those returns can slice the other
way. Extended Duration Treasury ETF
declined 35.6% in 2009 and dropped
17.0% in just the three months end-
ing July 2013. Not exactly what I
would call a “safe” holding. If you are
looking for Treasury bonds to insulate
your portfolio, you’d be better off in
Intermediate-Term Treasury, which
has regularly provided positive returns
when stocks were falling, but without
the wild ride of long-maturity bonds.
Treasury bonds, however, have their
own risks. While an effective counter
to declining stock prices, they are the
most sensitive to changes in interest
rates. With interest rates falling since
the early 1980s, Treasurys have had the
wind at their back for a long time, but
at some point rising rates will become
a headwind for Treasurys.
Money market funds, with their con-
stant $1.00 NAV, are another popular
flight-to-safety destination. Their advan-
tage over Treasury bonds is that they
are not impacted by changes in interest
rates. But with money market funds
yielding 0.01%, you are almost certainly
going to lose to inflation over time.
So is there a better alternative? One
shock absorber for a stock portfolio
that has the potential to make you some
money—but that still isn’t very sensi-
tive to changes in interest rates—is
Short-Term Investment-Grade. This
actively managed fund holds a hand-
ful of Treasurys but is more focused
on corporate bonds, and hence has a
higher yield than its Treasury-oriented
siblings at Vanguard. The combination
of a short maturity profile and relative
yield advantage has served the fund
well when interest rates rose. In 2013,
while its short-term peers struggled to
generate any return at all and Total
Bond Market Index declined 2.3%,
Short-Term Investment-Grade was able
to notch a return of 1.0%—tops among
all of Vanguard’s actively managed
investment-grade bond funds.
The fund isn’t without risk and has
the potential for price declines. In 2008,
anything that wasn’t Treasury-issued
was shunned by the market, and this
fund suffered for it, declining 7.6% at
its low point. However, its resilience can
be seen in its short recovery time of just
six months. Investors who can tolerate
some price moves should do much bet-
ter here than in a money market fund
over time.
Investors who are a bit more sensi-
tive to changes in price, but are still
looking for something to do with their
rainy day money should also consider
Vanguard’s new Ultra-Short-Term
DIVERSIFICATION
Should You Fly to Safety?