4
•
Fund Family Shareholder Association
IT’S NO SURPRISE
that stocks and
stock funds have generated strong
returns over the past five years. Just
take a look at the
Performance Review
inside this letter.
The question is: Howmuch of that
return did Vanguard investors actually
capture?
Returns reported by mutual fund
companies and other services like
Morningstar are point-in-time returns.
They assume that you made a single
investment at the start of a given time
period and simply reinvested distribu-
tions. This is a fair way to measure a
manager and fund’s performance—this
ishow I report performance toyou in the
PerformanceReview
onpages 8 through
11—but we know that, for better or
worse, investors are buying and selling
funds all the time. You may be adding
money on a monthly basis, and your
neighbor may be taking out chunks to
pay for her retirement. Then, of course,
there are those who either try to time
the market, or feel compelled to move
money around to try and capture some
mythical extra gain. As a result, point-
in-time returns don’t necessarily reflect
what investors actually earn.
Let’s walk through an example. Say
an investor puts $10,000 in a fund at
the start of the year. The fund returns
10.0% over the first six months of the
year. The investor, pleased with the
performance, decides to add$50,000 to
the fund. Unfortunately, over the next
six months the fund loses 2.5%. Up
10.0% and then down 2.5%works out
to a total return for the year of 7.3%.
However, once we account for our
investor’s cash flows, we discover that
hispersonal rateof return (calculatedas
an internal rateof return)was actually a
loss of 1.5%. How is that possible?
In simple terms, our luckless inves-
tor had a lot more money invested in
the fundwhen itwas on a losing streak,
so those negative returns countedmore
heavily inhis personal, dollar-weighted
rate of return.
During the first six months, the
investor made $1,000 (a 10.0% gain
on the initial $10,000 investment). At
the start of the second half of the year,
the investor had $61,000 invested in
the fund—the $10,000 initial invest-
ment, the $1,000 gain and the $50,000
addition. Over the next sixmonths, the
fund lost 2.5%, or $1,525, leaving him
with $59,475. Though the traditional
sources would report the fund gained
7.3% on the year, our investor actually
lost money ($525) due to the timing of
his trades.
This difference between the inves-
tor’s realized return and the fund’s
stated return (-1.5%versus 7.3%, inour
example) is often called the “behavior
gap.”As investors, our behavior has an
impact on the returns we realize. Are
we buying at tops and selling at bot-
toms, or arewe staying the course?
While the example above illustrates
a situation where the investor’s return
was less than the fund’s return, it is pos-
sible for an investor’s return tobehigher
than the fund’s return. Had our investor
started with a $50,000 investment and
PERFORMANCE
TheGap in Investor Returns
Mkt.
Return
Invest.
Return Diff.
EmergingMarkets Index 16.3% 6.2% -10.1%
REIT Index
29.4% 22.2% -7.2%
Capital Value
33.0% 27.4% -5.7%
World ex-U.S. Index
17.6% 12.1% -5.5%
Total International Stock 17.3% 12.0% -5.3%
HighDividendYield Idx.
23.4% 19.0% -4.4%
TotalWorldStock Index 19.9% 15.6% -4.4%
International Explorer
22.2% 18.7% -3.6%
Target Retirement 2050 20.2% 16.7% -3.5%
MidCapGrowth Index
26.1% 22.6% -3.5%
DividendApprec. Idx.
20.2% 16.8% -3.5%
Target Retirement 2040 20.2% 16.8% -3.4%
Target Retirement 2030 18.9% 15.4% -3.4%
SmallCapGrowth Index 29.9% 26.9% -2.9%
Target Retirement 2020 16.4% 13.6% -2.8%
Target Retirement 2045 20.2% 17.8% -2.5%
Target Retirement 2035 19.9% 17.6% -2.3%
Target Retirement Income 10.3% 8.1% -2.2%
MidCapValue Index
27.9% 25.7% -2.1%
Target Retirement 2025 17.6% 15.6% -2.0%
DevelopedMarkets Idx.
17.9% 15.9% -2.0%
SmallCap Index
29.0% 27.1% -1.9%
DividendGrowth
20.4% 18.7% -1.7%
Target Retirement 2010 13.4% 11.7% -1.7%
Strategic SmallCap Equ.
28.6% 27.0% -1.6%
Target Retirement 2015 15.1% 13.6% -1.5%
MidCapGrowth
25.3% 24.0% -1.3%
SmallCapValue Index
28.0% 26.7% -1.3%
Wellesley Income
13.7% 12.4% -1.3%
Managed Payout
16.1% 15.0% -1.2%
MidCap Index
27.1% 25.9% -1.1%
ExtendedMarket Index 28.2% 27.2% -1.0%
Equity Income
23.3% 22.3% -0.9%
PRIMECAPCore
23.9% 22.9% -0.9%
Total StockMarket
23.8% 23.0% -0.9%
Balanced Index
16.3% 15.7% -0.6%
SelectedValue
26.2% 25.6% -0.6%
Mkt.
Return
Invest.
Return Diff.
Value Index
22.5% 21.9% -0.5%
STAR Income
8.6% 8.1% -0.5%
International Growth
20.3% 19.8% -0.5%
LargeCap Index
23.0% 22.7% -0.4%
Growth Index
23.7% 23.4% -0.4%
STARCons. Gro.
12.1% 11.7% -0.3%
ConvertibleSecurities
17.6% 17.3% -0.3%
Energy
16.2% 15.9% -0.3%
Wellington
16.8% 16.6% -0.2%
Social Index
25.5% 25.3% -0.2%
500 Index
22.9% 22.7% -0.1%
International Value
17.4% 17.4% -0.0%
Admiral T-MBalanced 13.8% 13.8% -0.0%
Capital Opportunity
25.6% 25.6% -0.0%
STAR
16.8% 16.8% 0.1%
PreciousMetals&Mining 6.4% 6.5% 0.2%
HealthCare
25.1% 25.3% 0.2%
PRIMECAP
24.1% 24.5% 0.4%
MorganGrowth
23.3% 23.7% 0.4%
Admiral T-MSmallCap 27.9% 28.3% 0.4%
Admiral T-MCap. App.
23.6% 24.1% 0.5%
STARGrowth
18.8% 19.3% 0.6%
STARMod. Growth
15.5% 16.2% 0.7%
Diversified Equity
24.4% 25.2% 0.8%
Admiral T-MGro. & Inc.
22.9% 23.8% 0.9%
Windsor II
22.6% 23.6% 1.0%
Explorer
27.5% 28.7% 1.2%
Market Neutral
1.2% 2.4% 1.2%
U.S. Growth
23.0% 24.3% 1.3%
U.S. Value
23.1% 24.4% 1.4%
Windsor
25.1% 26.8% 1.7%
Growth& Income
22.5% 24.6% 2.1%
Global Equity
22.3% 24.8% 2.5%
Strategic Equity
28.5% 32.5% 4.0%
Pacific Index
14.8% 22.5% 7.7%
European Index
19.7% 28.5% 8.8%
Five-YearTurnaround
Note:All returnsare five-year annualized returns from theendof February2009 throughFebruary2014.Market returnsare returnsof the
investor shareclass. Investor returnswerecalculatedusingall shareclassesandmonthly fund flows. Entries in theDiff. columnmayappear
off by0.1%due to rounding.
