The Independent Adviser for Vanguard Investors
•
April 2014
•
5
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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
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
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
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.
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