(PUB) Investing 2015

a small amount of price devaluation, which, over time, should be more than recouped through higher monthly distri- butions. If you have more than a year’s worth of spending money sitting in a money market, you might want to take some of that excess and invest it here. One note: If you choose to put the bulk of your cash here, you should still keep a money market fund for your check-writing needs. Every check writ- ten on Short-Term Tax-Exempt results in a taxable transaction—something that will drive you and your accountant over the edge every April 15. Limited-TermTax-Exempt Buy. This is the fund to compare to the short-term taxables like Short-Term Treasury or Short-Term Investment- Grade. Duration, at 2.6 years, is right in line with its short-term taxable siblings. Risk is very limited here—there have only been two 12-month periods since the fund’s 1987 inception where it failed to deliver positive returns. With a yield well

Exempt’s yield of 0.48% isn’t any- thing to get excited about, but it has allowed the fund to deliver some gains over the past five years when Tax- Exempt Money Market has essentially shot a blank—just see the Performance Review on page 9. The fund has never had a 12-month stretch where it lost money and has outpaced Tax-Exempt Money Market in about 85% of the roll- ing 12-month periods since the money market fund’s 1980 inception. However, I don’t consider Short- Term Tax-Exempt a bond fund substi- tute either. The fund’s 0.8% annualized gain over the past five years is only half that of Limited-Term Tax-Exempt’s 1.6% per year return. And given that Limited-Term Tax-Exempt’s 0.98% yield is about double Short-Term Tax- Exempt’s yield, I wouldn’t expect that pattern to change. So how should one use Short-Term Tax-Exempt? It’s a good place to park money that you don’t need today or tomorrow if you’re willing to accept

FOCUS FROM PAGE 7

With all of that as prologue, here’s a look at Vanguard’s municipal bond options: Short-TermTax-Exempt Buy. As I said, compare this fund with its new taxable sibling Ultra-Short- Term Bond. However, as Ultra-Short- Term Bond is only eight months old, whereas Short-Term Tax-Exempt will be celebrating its 40th anniversary in two years, we can learn a lot more about the taxable bond fund by looking at the tax-free fund’s history. And the history says Short-Term Tax-Exempt has done its job very well—it just has a very spe- cific role to play in a portfolio. Short-Term Tax-Exempt isn’t a money market fund, as its share price does fluctuate. It’s more of a money market on steroids. The fund maintains some yield by pushing its portfolio’s average maturity and duration to a bit more than one year. Short-Term Tax-

ACTIVE-PASSIVE An Actively Passive Distraction FOR YEARS NOW, money has flowed out of actively managed funds and into index funds, with active management pronounced as good as dead at the end of 2014 and regular post-mortems a fixture of most invest- ment publications. This active versus passive debate is a favorite of the media, but over the years, the efficient-market theory upon which much of the debate has been built has morphed into something bigger, broader and much more ill-defined. And the sweeping generalizations that characterize this debate make it, to my mind, rather useless. In reality, the difference between a passive index investor and an active investor has never been as black-and-white as the media and marketing gurus would have you believe. Consider that Vanguard, widely considered the king of indexing, also oversees about $1.0 trillion in actively managed funds. So how can we make sense of it all? First, let’s be clear: The S&P 500 index, upon which so much historical data on indexing is based, is an actively managed index. Yes, that’s right. A committee, or what you and I might rightly call a team of portfolio managers, guided by some self-imposed restrictions on their investment “style,” decides which companies’ stocks to add to and which to drop from the venerable benchmark. Vanguard built its entire house of indexing—through the birth of 500 Index in August 1976—on an actively managed index. How’s that any different from an actively managed fund? The big difference is that S&P sells its “management” for a lower price (but much more broadly)

than the typical portfolio manager, by licensing the index to firms like Vanguard who wish to use it as the basis for an index product. Second, there’s nothing less active than an investor jumping from index fund to index fund (or ETF to ETF) looking for the next hot sector, region, or slice of the stock or bond markets. You don’t think this happens? Jack Bogle loves to recite statistics on the turnover of ETFs, which he likens to a beautiful shotgun with which you can shoot yourself. While ETFs may be considered “passive” investments, many investors who use them are more active than the active mutual fund managers they claim to abhor. And finally, the whole argument about the “average active manager” either outperforming or underperforming some benchmark is simply an easy-to-say but useless bit of data mining. The analysts at Morningstar, who really should know better, now produce what they call an Active/ Passive Barometer measuring active funds against index funds. But even this “barometer” is based on the average performance or asset-weighted performance of a host of different funds run by a small city’s worth of portfolio managers. Who cares about the average manager? The math tells you that the average manager, over time, will underperform, since every manager that outpaces the index is matched to a manager that falls behind. Add in the sometimes obscene operating expenses that some companies charge for their funds or their services (hedge funds being the worst), and the numbers will always fall, on average, in the index fund’s favor, assuming the index fund isn’t one of the price-gouging types you sometimes find labelled with a brokerage firm’s moniker. In many ways, the game of averages is the game Vanguard is play-

12 • Fund Family Shareholder Association

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