(PUB) Vanguard Advisor

March 2009—and Vanguard’s the low- cost leader, right? It has been nearly five years since their money market funds sported yields above 0.25%, and over two years since I could find a 0.10% yield. It’s been almost a year since there was a yield above 0.01%, or one basis point. The fact that Vanguard is going to great lengths—subsidizing some of the costs on a temporary basis to keep yields above zero—shows the toll that the Fed’s zero-interest-rate policy has taken on yields. The ultra-short-term bond market is fairly high quality, so there’s not much more a great fund man- ager can do than a mediocre manager to select great securities for a money mar- ket fund. In the end, it mainly comes down to costs. The lower your operat- ing expenses, presumably, the higher your money fund’s yield. Yet Vanguard, which has some of the lowest costs in the industry, still can’t get the yields on its money funds up over 0.01%. Annuity investors face a special case. See the box on page 6 for more on Money Market Annuity , but as the table above shows, Vanguard can’t keep investors’ yields in the black. It’s been losing value since Dec. 1, 2009. With core inflation running between 1.5% and 1.9%, money market assets aren’t coming anywhere close to keeping up with inflation—meaning the value of cash is slowly eroding. Consider the graph to the left, which plots the return of 500 Index , Total Bond Market and Prime Money Market as well as inflation over the past 25 years. Cash does give you a smooth ride, and at times like the market crash in 2008 and early 2009, simply holding cash at a then-bountiful yield above 1% looked like a smart move—but over an investment lifetime, returns from cash have fallen well short of those from stocks or bonds, and are only narrowly ahead of inflation. Over the last five years, inflation has sped well ahead of cash, up more than 10% cumulatively to Prime Money Market’s 0.2% gain. Given where we are today, with yields at zero, it’s almost certain that returns from money market funds will continue to fall short of inflation.

ZERO FROM PAGE 1 >

Rock Bottom Yields

are minimal. Why the need for new regulations in the first place? Money funds aim to maintain a con- stant net asset value (NAV) of $1.00. While the NAV reported in the paper and in your statement shows a stable $1.00, there is actually some movement below the surface. Money funds record “shadow” NAVs daily, which estimate the current market value of their secu- rities. Those daily NAVs often dance around $1.00 by a few thousandths of a dollar as the prices of the short-term securities held by the funds fluctuate day-to-day. But we rarely see these fluctuations, as the price for buying and selling shares is rounded to two decimal places. In a few rare instances, a money market’s reported NAV (or “price”) has dropped below $1.00. This is called “breaking the buck.” When that hap- pens, Wall Street shakes. Luckily, it’s a rare occurrence. The last fund to break the buck was the Reserve Fund during 2008’s credit-market lockup. Its fall prompted the SEC to review the rules applied to money market funds—in particular, whether money funds should begin reporting floating (or variable) NAVs rather than $1.00 per share. Fortunately, you and I can continue to rely on our funds being priced at $1.00 per share—no variable pricing for us individual investors. Institutional prime money funds, however, will shift to floating NAVs (showing prices out to four decimal places) by the end of a two-year transition period. The SEC also gave money funds (investor and institutional) the ability to charge a fee for redemptions or to suspend redemp- tions entirely for up to 10 days if there’s a run on assets during a crisis and liquidity dries up. None of the regulations—float- ing NAVs or the emergency fees and gates—apply to government money market funds. So if you wanted to com- pletely avoid the issue, you could con- sider something like Admiral Treasury Money Market —though as that fund is closed to new investors, you’ll have to look outside of Vanguard. But I’m not losing any sleep over the changes. For

Vanguard investors like us, I think this is a non-event. We keep the $1.00 NAV price, and Vanguard’s money funds continue to be safe and well-run. That’s the good news. Unfortunately, the yield or income we’re getting from our money funds these days is a serious problem. The Federal Reserve, which, as we discussed in last month’s issue, essen- tially sets short-term interest rates, last cut its fed funds rate to a range of 0.00% to 0.25% on Dec. 16, 2008, over five years ago. Money markets’ yields are generated by very short- term bonds that peg their own rates to what the Fed does. If the fed funds rate is low, so are money market yields. And money market yields are cur- rently so low you almost have to look up to see bottom. I’ll bet you never thought much of a money market fund yielding 1.00%. Big deal, right? Well, you and I haven’t seen a yield of 1.00% on any of Vanguard’s money market funds since CA Tax-Exempt Money Mkt. 0.01% 6/14/2011 NJ Tax-Exempt Money Mkt. 0.01% 6/14/2011 NY Tax-Exempt Money Mkt. 0.01% 6/14/2011 OH Tax-Exempt Money Mkt. 0.01% 7/5/2011 PA Tax-Exempt Money Mkt. 0.01% 6/8/2011 Money Market Annuity -0.21% * * Value began falling Dec. 1, 2009. Current Yield First Date Yield Hit 0.01% Admiral Treas. Money Mkt. 0.01% 12/7/2009 Federal Money Mkt. 0.01% 1/6/2010 Prime Money Mkt. 0.01% 2/18/2010 Tax-Exempt Money Mkt. 0.01% 6/20/2011

Cash Doesn’t Pay Over a Lifetime 500 Index Total Bond Market Index Prime Money Market Core CPI

$1,000 $1,200 $1,400 $1,600

$0 $200 $400 $600 $800

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4 • Fund Family Shareholder Association

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