(PUB) Investing 2015

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4 • Fund Family Shareholder Association
1990s. It followed that up with an annu-
alized return of 6.1% throughout the
2000s. And over the first five and a half
years of the current decade, Total Bond
Market has returned 3.8% annualized.
But with a yield of 2.12% at the end
of August, I would expect the fund’s
annual returns over the next 10 years to
run a lot closer to 2% than 6% or 7%.
The days of owning bonds for
growth and capital appreciation are
behind us. But those weren’t the real
reason to hold bonds in the first place.
Historically, you and I have owned
bond funds to generate income and pro-
vide a counterbalance to stock market
declines. I still think bonds will serve
the important role of shock absorbers
in our portfolios in the years to come.
We only need to look back to the 2008
credit crisis for an example. Stock prices
were cut in half over the 16 months from
the end of October 2007 through the end
of February 2009. 500 Index fell 51.0%.
At the end of that period, an investor
whose portfolio held nothing but shares
in 500 Index required a 104.0% gain just
to recoup those losses.
Compare that to an investor with
60% of her assets invested in 500
Index and 40% in Intermediate-Term
Treasury. With Intermediate-Term
Treasury up 14.1% over the same
16-month period, this balanced inves-
tor was down 24.9%, or just about half
of the loss incurred by someone with
all their money in stocks. Seeing your
account lose a quarter of its value can
be stressful, but it’s far more palatable
than seeing your account cut in half.
Plus, the balanced investor only needed
a gain of 33.2% to recover and resume
building profits. Again, to put that into
perspective, after bottoming out at the
end of February 2009 (using monthly
data), the all-stock investor would have
had to wait until August 2012 to recover
the losses, whereas the balanced inves-
tor would have recovered and begun to
earn new profits by October 2010—a
difference of almost two years.
Now, let’s make the comparison even
tougher on the bond side of the ledger.
What if, instead of getting that nice
14.1% return from Intermediate-Term
Treasury during the financial crisis, we
swapped in a difficult 16-month stretch
for the bond fund? Take a more recent
hiccup in the bond markets—the “taper
tantrum” in 2013, for example.
The taper tantrum, for those who
have forgotten, was the reaction among
bond investors to then-Fed Chairman
Ben Bernanke’s announcement in May
2013 that the Fed was going to first
reduce then eventually stop purchasing
bonds. Bond investors sold on the news,
and the yield on the 10-year Treasury
jumped nearly a full 1% from 1.76% at
the end of April 2013 to 2.74% at the
end of August that year, an increase of
more than 50%. The 10-year’s price
dropped 8.1%, and Intermediate-Term
Treasury declined 4.3% in four short
months.
A balanced portfolio that combined
the worst stretch in 500 Index’s history
with Intermediate-Term Treasury’s run
during the taper tantrum would have lost
more than our first balanced investor (no
surprise there), but still would have come
out a good deal ahead of the investor
who put all of his money into 500 Index.
Even after a 31.2% decline, the taper tan-
trum balanced investor would only have
needed a 45.4% gain to recover. That’s
a far cry from that 104.0% recovery our
stocks-only investor needed.
The taper tantrum is relevant for
investors today because the environ-
ment hasn’t changed all that much—
interest rates are at roughly the same
low level, and the economy is plowing
along on a similar slow-growth path.
Still, in the table below, Jeff and I ran
the numbers using other “worst-case”
scenarios. The worst 16-month stretch
for Intermediate-Term Treasury came
in 1999. 1994 and early 1995 saw a par-
ticularly sharp action from the Fed as
the fed funds rate jumped from 3.00%
to 6.00%. To pull in an example from
before the bond bull market began, I
looked at one of Vanguard’s oldest bond
funds, GNMA, and its worst 16-month
stretch, which took place starting in
1981 (Intermediate-Term Treasury only
launched in 1991).
In each of these hypothetical worst-
case scenarios using periods when
bonds acted poorly, the balanced inves-
tor’s portfolio lost around a third of its
value and needed a gain of 50% or so
to recover—far better than the investor
who avoided bonds completely.
It’s possible for stocks and bonds
to lose money at the same time, but it
is hard to envision a scenario where
stocks enter a bear market and bonds
decline even more. If you are looking
to control your risk and help smooth
out the ride, then bonds absolutely still
have a place in your portfolio.
So, since I’m hoping you’re now
thoroughly convinced that owning
bonds is part of a good long-term strat-
egy, let’s examine which of Vanguard’s
myriad fixed-income funds may be
appropriate for you.
The Vanguard Formula
When it comes to bond funds, the
Vanguard formula is tried and true, and
well-tested: Keeping costs low means
the portfolio managers don’t have to
take added risk for added income, or as
it’s known, to “reach for yield.” Instead,
they are able to build plain-vanilla
portfolios that have been very com-
petitive from both a yield and a total
return perspective. I remain confident
in Vanguard’s ability to execute these
strategies well, both on its indexed and
actively managed funds. Remember,
FOCUS FROM PAGE 1 >
Even at Their Worst, Bonds Play a Role
Loss
Gain
Needed to
Recover
Bond
Returns Bond MCL
100% Stocks (2008) -51.0% 104.0% — —
60% Stocks + 40% GNMA (1980) -32.7% 48.7% -5.4% -12.3%
60% Stocks + 40% Interm.-Term Treasury (1999) -32.4% 48.0% -4.7% -4.7%
60% Stocks + 40% Interm.-Term Treasury (1994) -31.7% 46.5% -2.9% -6.5%
60% Stocks + 40% Interm.-Term Treasury (2013) -31.2% 45.4% -1.6% -4.3%
60% Stocks + 40% Interm.-Term Treasury (2008) -24.9% 33.2% 14.1% -3.4%
Note: Table shows hypothetical returns pairing 500 Index’s 16-month financial crisis loss with the worst 16-month periods for Intermediate-Term
Treasury and GNMA.