(PUB) Investing 2015

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- 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

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- 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 ETFS What Price Glory?

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 > 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. n

The Independent Adviser for Vanguard Investors • February 2015 • 5

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