Sa 2113062 Vanguard Investment Principles Eng

Vanguard’s
Principles for
Investing Success
For institutional and sophisticated investors only. Not for public distribution.
Successful investment management companies base their business on a core
investment philosophy, and Vanguard is no different. Although we offer many
specific strategies through both internally and externally managed funds, an
overarching theme runs through the investment guidance we provide to clients—
focus on those things within your control.
Instead, too many focus on the markets, the economy, manager ratings, or the
performance of an individual security or strategy, overlooking the fundamental
principles that we believe can give them the best chance of success.
These principles have been intrinsic to our company since its inception, and they
are embedded in its culture. For Vanguard, they represent both the past and the
future—enduring principles that guide the investment decisions we help our
clients make.
Notes on risk: All investing is subject to risk, including possible loss of principal. Past performance does not
guarantee future results. There is no guarantee that any particular asset allocation or mix of funds will meet
your investment objectives or provide you with a given level of income. Diversification does not ensure a
profit or protect against a loss. Bond funds are subject to the risk that an issuer will fail to make payments on
time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s
ability to make payments. High-yield bonds generally have medium- and lower-range credit-quality ratings and
are therefore subject to a higher level of credit risk than bonds with higher credit-quality ratings. Although the
income from a municipal bond fund is exempt from federal tax, you may owe taxes on any capital gains
realized through the fund’s trading or through your own redemption of shares. For some investors, a portion
of the fund’s income may be subject to state and local taxes, as well as to the federal Alternative Minimum
Tax. Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/
regional risk and currency risk. These risks are especially high in emerging markets. Prices of mid- and small-
capitalization stocks often fluctuate more than those of large-company stocks. Funds that concentrate on a
relatively narrow market sector face the risk of higher share-price volatility. The performance of an index is
not an exact representation of any particular investment, as you cannot invest directly in an index.
b
Goals Create clear, appropriate
investment goals.
2
Balance Develop a suitable asset

allocation using broadly
8
diversified funds.
Cost Minimize cost. 17
Discipline Maintain perspective

and long-term discipline.
24
For institutional
1 and sophisticated investors only. Not for public distribution.
Goals
Create clear, appropriate investment goals.
An appropriate investment goal should be measurable and attainable.

Success should not depend upon outsize investment returns, nor upon
impractical saving or spending requirements.
Defining goals clearly and being realistic about ways to achieve them can help
protect investors from common mistakes that derail their progress. Here we
show that:
■■ Recognizing constraints, especially those that involve risk-taking, is essential to
developing an investment plan.
■■ A basic plan will include specific, attainable expectations about contribution rates
and monitoring.
■■ Discouraging results often come from chasing overall market returns, an unsound
strategy that can seduce investors who lack well-grounded plans for achieving
their goals.
■■ Without a plan, investors can be tempted to build a portfolio based on transitory
factors such as fund ratings—something that can amount to a “buy high, sell
low” strategy.
2 For institutional and sophisticated investors only. Not for public distribution.
Defining the goal and constraints
A sound investment plan—or policy statement, for institutions—begins by outlining the investor’s
objective as well as any significant constraints. Defining these elements is essential because the
plan needs to fit the investor; copying other strategies can prove unwise. Because most objectives
are long-term, the plan should be designed to endure through changing market environments,
and should be flexible enough to adjust for unexpected events along the way. If the investor has
multiple goals (for example, paying for both retirement and a child’s college expenses), each needs
to be accounted for. Once the plan is in place, the investor should evaluate it at regular intervals.
FIGURE 1
Example of a basic framework for an investment plan
Objective Save $1 million for retirement, adjusted for inflation.
Constraints 30-year horizon.
Moderate tolerance for market volatility and loss; no tolerance for nontraditional risks.1
Current portfolio value: $50,000.
Monthly net income of $4,000; monthly expenses of $3,000.
Effect of taxes on returns.
Saving or spending target Willing to contribute $5,000 in the first year.
Intention to raise the contribution by $500 per year, to a maximum of $10,000 annually.
Asset allocation target 70% allocated to diversified stock funds; 30% allocated to diversified bond funds.
Allocations to foreign investments as appropriate.
Rebalancing methodology Rebalance annually.
Monitoring and evaluation Periodically evaluate current portfolio value relative to savings target, return expectations, and
long-term objective.
Adjust as needed.
This example is completely hypothetical. It does not represent any real investor and should not be taken as a guide. Depending on an actual investor’s circumstances, such a plan or
investment policy statement could be expanded or consolidated. For example, many financial advisors or institutions may find value in outlining the investment strategy, i.e., specifying
whether tactical asset allocation will be employed, whether actively or passively managed funds will be used, and the like.
Source: Vanguard.
1 T here are many definitions of risk, including the traditional definitions (volatility, loss, and shortfall) and some nontraditional ones (liquidity, manager, and leverage). Investment
professionals commonly define risk as the volatility inherent to a given asset or investment strategy. More information on various risk metrics used in the financial industry was
presented in Ambrosio (2007).
For institutional and sophisticated investors only. Not for public distribution. 3
Most investment goals are straightforward—saving for retirement, preserving assets, funding
a pension plan, or meeting a university’s spending requirements, for example. Constraints,
on the other hand, can be simple or complex, depending on the investor and the situation.
The primary constraint in meeting any objective is the investor’s tolerance for market risk.
Importantly, risk and potential return are generally related, in that the desire for greater return
will require taking on greater exposure to market risk.
In most cases, the investment time horizon is another key constraint; for example, a university
endowment with a theoretically infinite horizon might take some risks that would be unwise
for an investor looking to fund a child’s college education. Other constraints can include
exposure to taxes, liquidity requirements, legal issues, or unique factors such as a desire to
avoid certain investments entirely. Because constraints may change over time, they should
be closely monitored.
The danger of lacking a plan
Without a plan, investors often build their portfolios from the bottom up, focusing on
investments piecemeal rather than on how the portfolio as a whole is serving the objective.
Another way to characterize this process is “fund collecting”: These investors are drawn to
evaluate a particular fund, and, if it seems attractive, they buy it, often without thinking about
how or where it may fit within the overall allocation.
Figure 2 demonstrates that such behavior is unproductive. It shows how investors have
tended to flock to funds with high performance ratings, even as those ratings have proven
to be an unreliable guide to future performance.
While paying close attention to each investment may seem logical, this process can lead
to an assemblage of holdings that doesn’t serve the investor’s ultimate needs. As a result,
the portfolio may wind up concentrated in a certain market sector, or it may have so many
holdings that portfolio oversight becomes onerous. Most often, investors are led into such
imbalances by common, avoidable mistakes such as performance chasing, market-timing,
or reacting to market “noise.”
FIGURE 2
Investors tend to buy highly rated funds, but ratings are an unreliable guide to the future
Mean performance of Fund ratings

stock funds versus primary
prospectus benchmarks 0
annualized over the 36
performance relative to benchmark
months following a
Annualized 36-month fund
(in percentage points)
Morningstar rating –1.5
–3.0
–4.5
–6.0
Cash flows for Morningstar- $200

rated stock funds in periods Ratings
after the ratings were posted 150 5-star
Cumulative cash flow (billions)
4-star
100
3-star
50 2-star
1-star
0
–50
–100
–150
One year Three years Five years
Notes: Morningstar ratings are designed to bring returns, risks, and adjustments for sales loads together into one evaluation. To determine a fund’s star rating for a given time period
(three, five, or ten years), the fund’s risk-adjusted return is plotted on a bell curve. If the fund scores in the top 10% of its category, it receives five stars; in the next 22.5%, four stars; in
the middle 35%, three stars; in the next 22.5%, two stars; and in the bottom 10%, one star. The overall rating is a weighted average of the available three-, five-, and ten-year ratings.
To calculate the mean performance versus the primary prospectus benchmark, Vanguard first grouped actively managed funds according to their star ratings as of January 1, 2016. We
then computed the mean annualized excess return versus the primary prospectus benchmark for the subsequent 36-month period through December 2019.
Sources: Data on cash flows, fund returns, ratings, and excess returns were provided by Morningstar, Inc. More information was presented in Philips and Kinniry (2010).
Many investors—both individuals and institutions—are moved to action by the performance
of the broad stock market, increasing their stock exposure during bull markets and reducing it
during bear markets. Such “buy high, sell low” behavior is evident in mutual fund cash flows
that mirror what appears to be an emotional response—fear or greed—rather than a rational
one. Figure 3 shows that investors in aggregate tend to move cash in and out of equity
investments in patterns that coincide with recent performance of the equity market.
A sound investment plan can help the investor avoid such behavior because it demonstrates
the purpose and value of asset allocation, diversification, and rebalancing. It also helps the
investor stay focused on intended contribution and spending rates.
We believe investors should employ their time and effort up front, on the plan, rather than in
evaluating each new idea that hits the headlines. This simple step can pay off tremendously
in helping them stay on the path toward their financial goals.
FIGURE 3
Mutual fund cash flows often follow performance
80% $200
12-month rolling net equity
60 150 flows (USD billions)
12-month rolling equity return
Rolling net equity flows
Rolling equity returns
40 100
20 50
0 0
–20 –50
–40 –100
–60 –150
2005 2007 2009 2011 2013 2015 2017 2019
Notes: Net flows represent net cash moving in or out of equity funds for all U.S.-domiciled mutual funds and ETFs. Market returns are based on the MSCI USA Investable Market Index.
Sources: Vanguard calculations, using data from Morningstar, Inc.
The key takeaway
The best way to work toward an investment goal is to start by defining it clearly, take a
level-headed look at the means of getting there, and then create a detailed, specific plan.
Being realistic is essential to this process: Investors need to recognize their constraints and
understand the level of risk they are able to accept.
They also need to be clear-eyed about the markets, because research has shown that pinning
one’s hopes on outsize market returns—or on finding some investment that will outperform
the markets—is not the most likely road to success.
Balance
Develop a suitable asset allocation using broadly diversified funds.
A sound investment strategy starts with an asset allocation suitable for

the portfolio’s objective. The allocation should be built upon reasonable
expectations for risk and returns, and should use diversified investments
to avoid exposure to unnecessary risks.
Both asset allocation and diversification are rooted in the idea of balance. Because
all investments involve risk, investors must balance risk and potential reward
through the choice of portfolio holdings. Here we provide evidence that:
■■ A diversified portfolio’s proportions of stocks, bonds, and other investment types
determine most of its return as well as its volatility.
■■ Attempting to escape volatility and near-term losses by minimizing stock
investments can expose investors to other types of risk, including the risks of
failing to outpace inflation or falling short of an objective.
■■ Realistic return assumptions—not hopes—are essential in choosing an allocation.
■■ Leadership among market segments changes constantly and rapidly, so investors
must diversify both to mitigate losses and to participate in gains.
The importance of asset allocation
When building a portfolio to meet a specific objective, it is critical to select a combination

of assets that offers the best chance for meeting that objective, subject to the investor’s
constraints.2 Assuming that the investor uses broadly diversified holdings, the mix of those
assets will determine both the returns and the variability of returns for the aggregate portfolio.
This has been well documented in theory and in practice. For example, the seminal 1986
study by Brinson, Hood, and Beebower was confirmed by Scott et al. (2017), a paper that
showed that the asset allocation decision was responsible for 91.1% of a diversified portfolio’s
return patterns over time (Figure 4).
FIGURE 4
Investment outcomes are largely determined b
y the long-term mixture of assets in a portfolio
Security selection a nd market timing 8.9%
Percentage of a
portfolio’s movements
over time explained by:
Asset allocation 91.1%
Notes: Calculations are based on monthly returns for 709 American funds from January 1990 to September 2015. More details of the methodology were presented in Scott et al. (2017).
2 For asset allocation to be a driving force of an outcome, one must implement the allocation using vehicles that approximate the return of market indexes. This is because market indexes
are commonly used in identifying the risk and return characteristics of asset classes and portfolios. Using a vehicle other than one that attempts to replicate a market index will deliver
a result that may differ from the index result, potentially leading to outcomes different from those assumed in the asset allocation process. To make the point with an extreme example:
Using a single stock to represent the equity allocation in a portfolio would likely lead to very different outcomes than either a diversified basket of stocks or any other single stock.
In Figure 5 we show a simple example of this relationship using two asset classes—U.S.
stocks and U.S. bonds—to demonstrate the impact of asset allocation on both returns and
the variability of returns. The numbers in the middle of the bars in the chart show the average
yearly return since 1926 for various combinations of stocks and bonds. The bars represent the
best and worst one-year returns. Although this example covers an unusually extended holding
period, it shows why an investor whose portfolio is 20% allocated to U.S. stocks might
expect a very different outcome than an investor with 80% allocated to U.S. stocks.
FIGURE 5
The mix of assets defines the spectrum of returns
Best, worst, and average returns for various stock/bond allocations, 1926–2019
Portfolio allocation
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Bonds
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Stocks
Annual returns 60% 54.2%

49.8%
50 45.4%
41.1%
40 36.7%
32.6% 31.2% 32.3%
29.8% 28.4% 27.9%
30
20
10 7.2% 7.8% 8.3% 8.8% 9.2% 9.6% 10.0% 10.3% Average
5.3% 6.0% 6.6%
0
–10 –8.2%
–8.1% –10.1%
–20 –14.2%
–18.4%
–22.5%
–30 –26.6%
–30.7%
–40 –34.9%
–39.0%
–50 –43.1%
Notes: Stocks are represented by the Standard & Poor’s 90 Index from 1926 to March 3, 1957; the S&P 500 Index from March 4, 1957, through 1974; the Wilshire 5000 Index from 1975
through April 22, 2005; and the MSCI US Broad Market Index thereafter. Bonds are represented by the S&P High Grade Corporate Index from 1926 through 1968; the Citigroup High Grade
Index from 1969 through 1972; the Bloomberg Barclays U.S. Long Credit AA Index from 1973 through 1975; and the Bloomberg Barclays U.S. Aggregate Bond Index thereafter. Data are
through December 31, 2019.
Stocks are risky—and so is avoiding them
Stocks are inherently more volatile than investments such as bonds or cash instruments.
This is because equity owners are the first to realize losses stemming from business risk,
while bond owners are the last. In addition, whereas bond holders are contractually promised
a stated payment, equity holders own a claim on future earnings. But the level of those
earnings, and how the company will use them, is beyond the investor’s control. Investors thus
must be enticed to participate in a company’s uncertain future, and the “carrot” that entices
them is higher expected or potential return over time.
Figure 5 also demonstrates the short-term risk of owning stocks: Even a portfolio with
only half its assets in stocks would have lost more than 22% of its overall value in at least
one year. Why not simply minimize the possibility of loss and finance all goals using low-
risk investments? Because the attempt to escape market volatility associated with stock
investments by investing in more stable, but lower-returning, assets such as U.S. Treasury
bills can expose a portfolio to other, longer-term risks.
One such risk is “opportunity cost,” more commonly known as shortfall risk: Because the
portfolio lacks investments that carry higher potential return, it may not achieve growth
sufficient to finance ambitious goals over the long term. Or it may require a level of saving that
is unrealistic, given more immediate demands on the investor’s income or on cash flow (in the
case of an endowment or pension fund, for example). Another risk is inflation: The portfolio
may not grow as fast as prices rise, so the investor loses purchasing power over time. For
longer-term goals, inflation can be particularly damaging, as its effects compound over long
time horizons. For example, Bennyhoff (2009) showed that over a 30-year horizon, an average
inflation rate of 3% would reduce a portfolio’s purchasing power by more than 50%.
For investors with longer time horizons, inflation risks may actually outweigh market risks,
often necessitating a sizable allocation to investments such as stocks.
Use reasonable assumptions in choosing an allocation
Just as important as the combination of assets that are used to construct a portfolio are the
assumptions that are used to arrive at the asset allocation decision. By this we mean using
realistic expectations for both returns and volatility of returns. Using long-term historical data
may serve as a guide, but investors must keep in mind that markets are cyclical and it is
unrealistic to use static return assumptions. History does not repeat, and the market conditions
at a particular point in time can have an important influence on an investor’s returns.
For example, over the history of the capital markets since 1926, U.S. stocks returned an
average of 10.3% annually and U.S. bonds 5.3% (based on the same market benchmarks
used in Figure 5). For this 93-year period, a half-stock, half-bond portfolio would have returned
8.3% a year on average if it matched the markets’ return.
But look at a shorter span, and the picture changes. For example, from 1980 through 2019,
U.S. stocks returned an average of 11.6% a year, while bonds returned 7.5%. A portfolio split
evenly between the two asset classes and rebalanced periodically would have generated
an average annual return of 9.9%. As you can see, anyone with such a portfolio over this
particular period could have earned 1.6 percentage points a year more than the long-term
historical average of 8.3%. Contrast that with the period from 2000 through 2019, when
U.S. stocks provided a 6.4% average return and U.S. bonds 5.0%; then, the same balanced
portfolio would have averaged 6.2% a year.
In practice, investors will always need to decide how to apply historical experiences to current
market expectations. For example, as Davis et al. reported in Vanguard Economic and Market
Outlook for 2020: The New Age of Uncertainty (2019), returns over the next decade may look
very different from the examples above as a result of current market conditions. Particularly
for bonds, the analysis provided in the paper suggests that returns may be lower than what
many investors have grown accustomed to. The implication is that investors may need to
adjust their asset allocation assumptions and contribution/spending plans to meet a future
objective that could previously have seemed easily achievable based on historical values alone.
FIGURE 6
Market segments display seemingly random patterns of performance
Annual returns for various investment categories ranked by performance, best to worst: 2005–2019
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Best
34.54% 45.58% 39.82% 5.75% 79.02% 28.43% 8.29% 40.88% 38.39% 30.14% 3.20% 18.54% 37.75% 3.17% 31.49%
21.36% 35.06% 16.23% 5.24% 58.21% 27.96% 7.84% 18.63% 32.39% 13.69% 1.38% 17.13% 26.59% 0.01% 28.06%
17.44% 32.55% 12.92% –14.75% 47.54% 19.20% 6.97% 18.06% 21.57% 8.79% 1.36% 11.96% 24.81% –2.08% 26.00%
14.96% 26.23% 6.97% –26.16% 36.99% 17.23% 4.98% 17.99% 7.44% 7.97% 1.29% 11.77% 21.83% –2.46% 23.16%
12.27% 15.79% 5.49% –35.65% 34.39% 16.83% 3.94% 17.95% 4.35% 5.97% 0.55% 11.60% 17.84% –4.38% 21.91%
12.16% 15.28% 5.39% –37.00% 34.23% 15.12% 2.11% 17.01% 2.47% 4.76% –1.77% 9.88% 8.17% –4.62% 18.90%
10.03% 11.85% 5.15% –37.73% 27.99% 15.06% –4.10% 16.00% 1.18% 3.43% –2.60% 8.52% 7.50% –9.40% 14.32%
5.42% 9.96% 4.27% –39.03% 26.46% 12.84% –11.78% 15.81% –2.02% 2.45% –2.65% 4.90% 5.23% –9.53% 13.11%
4.91% 4.33% 1.91% –43.23% 18.91% 9.43% –13.32% 6.46% –2.27% –1.82% –4.47% 3.29% 3.54% –11.25% 8.72%
2.74% 3.19% 1.87% –52.98% 5.93% 6.54% –16.01% 4.21% –4.12% –3.88% –14.60% 2.65% 2.48% –13.64% 7.69%
Worst
2.43% 2.07% –15.69% –53.18% 4.43% 3.28% –18.17% –1.06% –9.52% –17.01% –24.66% 2.02% 1.70% –14.25% 7.57%
U.S. stocks Non-U.S. stocks U.S. bonds Non-U.S. bonds Other
FTSE NAREIT Equity MSCI World ex USA Bloomberg Barclays U.S. Bloomberg Barclays Bloomberg Barclays
REIT Index Index Aggregate Bond Index Emerging Markets USD Commodity Index
Aggregate Bond Index
S&P 500 Index MSCI Emerging Markets Bloomberg Barclays U.S.
Index Corporate High Yield Bloomberg Barclays
Wilshire 4500 Bond Index Global Aggregate
Completion Index S&P Global ex-U.S. ex-U.S. Index (Hedged)
Property Index
Notes: Benchmarks reflect the following asset classes—for large-capitalization U.S. stocks, the S&P 500 Index; for mid- and small-cap U.S. stocks, the Wilshire 4500 Completion Index; for
developed international stock markets, the MSCI World ex USA Index; for emerging markets, the MSCI Emerging Markets Index; for commodities, the Bloomberg Barclays Commodity Index;
for U.S. real estate, the FTSE NAREIT Equity REIT Index; for international real estate, the S&P Global ex-U.S. Property Index; for U.S. investment-grade bonds, the Bloomberg Barclays U.S.
Aggregate Bond Index; for U.S. high-yield bonds, the Bloomberg Barclays U.S. Corporate High Yield Bond Index; for international bonds, the Bloomberg Barclays Global Aggregate ex-U.S.
Index (Hedged); and for emerging-market bonds, the Bloomberg Barclays Emerging Markets USD Aggregate Bond Index.
Source: Morningstar, Inc.
Diversify to manage risk
Diversification is a powerful strategy for managing traditional risks.3 Diversifying across asset
classes reduces a portfolio’s exposure to the risks common to an entire class. Diversifying
within an asset class reduces exposure to risks associated with a particular company, sector,
or segment.
In practice, diversification is a rigorously tested application of common sense: Markets will

often behave differently from one another—sometimes marginally, sometimes greatly—at
any given time. Owning a portfolio with at least some exposure to many or all key market
components ensures the investor of some participation in stronger areas while mitigating
the impact of weaker areas. See for example Figure 6, on page 13, where we show annual
returns for a variety of asset and sub-asset classes. The details of Figure 6 don’t matter so
much as its colorful patchwork, which shows how randomly leadership can shift among
markets and market segments.
Performance leadership is quick to change, and a portfolio that diversifies across markets
is less vulnerable to the impact of significant swings in performance by any one segment.
Investments that are concentrated or specialized, such as real estate investment trusts
(REITs), commodities, or emerging markets, also tend to be the most volatile. This is why
we believe that most investors are best served by significant allocations to investments
that represent broad markets such as U.S. stocks, U.S. bonds, international stocks, and
international bonds.4
3 Diversification carries no guarantees, of course, and it specifically may not mitigate the kinds of risks associated with illiquid assets, counterparty exposure, leverage, or fraud.
4 We believe that if international bonds are to play an enduring role in a diversified portfolio, the currency exposure should be hedged. Additional perspective, including an analysis of the
impact of currency on the return characteristics of foreign bonds, was presented in Philips et al. (2014).
Although broad market diversification cannot insure an investor against loss, it can help to
guard against unnecessarily large losses. One example: In 2008, the Standard & Poor’s
500 Index returned –37%. However, more than a third of the stocks in the index that year
had individual returns worse than –50%.5 Some of the worst performers in the index would
probably have been viewed as blue-chip companies not long before. They were concentrated
in the financial sector, considered a staple in many dividend-focused portfolios (Figure 7).6
Although this example comes from the stock market, other asset classes and sub-classes
can provide many of their own. It’s worth saying again that, while diversification cannot insure
against loss, undiversified portfolios have greater potential to suffer catastrophic losses.
FIGURE 7
The ten worst and best stocks in the S&P 500 Index in 2008
Worst performers Return Best performers Return
Lehman Brothers Holdings Inc. –99.67% Family Dollar Stores, Inc. 38.62%
Washington Mutual, Inc. –99.39 UST Inc. 31.96
American International Group, Inc. –97.25 H&R Block, Inc. 25.77
General Growth Properties, Inc. –96.49 Amgen Inc. 24.35
Fannie Mae –96.06 Barr Pharmaceuticals, Inc. 23.92
Freddie Mac –94.87 Synovus Financial Corp. 23.40
Ambac Financial Group, Inc. –94.75 Wal-Mart Stores, Inc. 20.00
XL Capital Ltd. (Class A) –92.15 Celgene Corp. 19.63
American Capital, Ltd. –89.05 Rohm and Haas Co. 19.44
National City Corp. –88.75 Hasbro, Inc. 16.82
Sources: Vanguard and FactSet.
5 A 50% loss requires a 100% return to break even, while a 37% loss requires a 59% return to break even.
6 Further discussion was presented in Bennyhoff (2009).
The key takeaway
Asset allocation and diversification are powerful tools for achieving an investment goal. A
portfolio’s allocation among asset classes will determine a large proportion of its return— and
the majority of its volatility risk. Broad diversification reduces a portfolio’s exposure to specific
risks while providing opportunity to benefit from the markets’ current leaders.
Cost
Minimize cost.
Markets are unpredictable. Costs are forever. The lower your costs,
the greater your share of an investment’s return. And research suggests
that lower-cost investments have tended to outperform higher-cost
alternatives. To hold on to even more of your return, manage for tax
efficiency. You can’t control the markets, but you can control the bite
of costs and taxes.
To show why it is essential to consider cost when choosing investments,

we provide evidence that:
■■ Higher costs can significantly depress a portfolio’s growth over long periods.
■■ Costs create an inevitable gap between what the markets return and what
investors actually earn—but keeping expenses down can help narrow that gap.
■■ Lower-cost mutual funds have tended to perform better than higher-cost funds
over time.
■■ Indexed investments can be a useful tool for cost control.
Why cost matters
Minimizing cost is a critical part of every investor’s toolkit. This is because in investing,
there is no reason to assume that you get more if you pay more. Instead, every dollar paid
for management fees or trading commissions is simply a dollar less earning potential return.
The key point is that—unlike the markets—costs are largely controllable.
Figure 8 illustrates how strongly costs can affect long-term portfolio growth. It depicts the
impact of expenses over a 30-year horizon in which a hypothetical portfolio with a starting
value of $100,000 grows an average of 6% annually. In the low-cost scenario, the investor
pays 0.25% of assets every year, whereas in the high-cost scenario, the investor pays
0.62%, or the approximate asset-weighted average expense ratio for U.S. stock funds as
of December 31, 2019 (average expense ratio according to Morningstar calculations). The
potential impact on the portfolio balances over three decades is real—a difference of more
than $55,000 between the low-cost and high-cost scenarios.
FIGURE 8
The long-term impact of investment costs on portfolio balances
Assuming a starting balance of $100,000 and a yearly return of 6%, which is reinvested
$600,000
$574,349 Before cost
$532,899 After 0.25% cost
500,000
$477,141 After 0.62% cost
Portfolio value
400,000
300,000
200,000
100,000
0 5 10 15 20 25 30
Years
Notes: The portfolio balances shown are hypothetical and do not reflect any particular investment. The rate is not guaranteed. The final account balances do not reflect any taxes
or penalties that might be due upon distribution. Costs are one factor that can impact returns. There may be other material differences between products that must be considered
prior to investing.
Figure 9 looks at the impact of costs in another way—by illustrating how they cause the
return of investors in aggregate to trail the overall market return. It shows a bell-shaped
distribution of returns, from lowest to highest, with the average return marked by a vertical
line. In any market, the average return for all investors before costs is, by definition, equal to
the market return. Once various costs are accounted for, however, the distribution of returns
realized by investors moves to the left, because their aggregate return is now less than the
market’s. The actual return for all investors combined is thus the market return reduced by all
costs paid. One important implication of this is that, after costs, fewer investors are able to
outperform the markets (occupying the shaded area in Figure 9).
Reduce cost to help improve return
There are two ways to shift an investor’s after-cost return to the right, toward the shaded
region. The first is to earn higher returns than the average investor by finding a winning
manager or a winning investment strategy (an “alpha” or “skill-based” approach).
FIGURE 9
The impact of costs on overall investor returns
Hypothetical distributions of market returns before and after costs
Average investor return after costs Average investor return before costs
is less than market return equals market return
Distribution of investor returns Distribution of investor returns

after costs are considered: before costs are considered:
Less than 50% of invested 50% of invested dollars outperform;
dollars outperform; more than 50% underperform
50% underperform
Impact of
costs
Lower return Higher return
Note: These distributions are theoretical and do not reflect any set of actual returns.
Source: Vanguard.
Unfortunately, research shows that this is easier said than done (Rowley et al., 2019). The
second way is to minimize expenses. Figure 10 highlights five studies evaluating the impact
of costs on performance. The common thread among them is that higher costs lead to worse
performance for the investor.
Figure 11 compares the ten-year records of the median funds in two groups: the 25% of
funds that had the lowest expense ratios as of year-end 2019 and the 25% that had the
highest, based on Morningstar data. In every category we evaluated, the low-cost fund
outperformed the high-cost fund.
Indexing can help minimize costs
If—all things being equal—low costs are associated with better performance, then costs
should play a large role in the choice of investments. As Figure 12 shows, index funds and
indexed exchange-traded funds (ETFs) tend to have costs among the lowest in the mutual
fund industry. As a result, indexed investment strategies can actually give investors the
opportunity to outperform higher-cost active managers—even though an index fund simply
FIGURE 10
Higher costs make for unhappy news: Studies document effects on performance
Martin J. Gruber, in a study on growth in the mutual fund industry, found that high fees were associated with inferior
performance, and that better-performing managers tended not to raise fees to reflect their success. After ranking funds
1996
by their after-expense returns, Gruber reported that the worst performers had the highest average expense ratio and that
the return differences between the worst and best funds exceeded the fee differences.
Mark Carhart followed with a seminal study on performance persistence in which he examined all the diversified equity
1997
mutual funds in existence between 1962 and 1993. Carhart showed that expenses proportionally reduce fund performance.
Financial Research Corporation evaluated the predictive value of various fund metrics, including past performance,
2002 Morningstar rating, alpha, and beta, as well as expenses. The study found that a fund’s expense ratio was the most reliable
predictor of its future performance, with low-cost funds delivering above-average performance in all the periods examined.
Christopher B. Philips and Francis M. Kinniry Jr. showed that using a fund’s Morningstar rating as a guide to future
performance was less reliable than using the fund’s expense ratio. Practically speaking, a fund’s expense ratio is a
2010
valuable guide (although of course not a certain one), because the expense ratio is one of the few characteristics that
are known in advance.
Daniel W. Wallick and colleagues evaluated the associations between a fund’s performance and its size, age, turnover,
2015 and expense ratio. They found that the expense ratio was a significant factor associated with future alpha (return above
that of a market index).
FIGURE 11
Lower costs can support higher returns
Average annual returns over the ten years through 2019
16%
12
Average annual return
0
Value Blend Growth Value Blend Growth Value Blend Growth Gov’t Corp. Gov’t Corp. High-yield
Large-cap Mid-cap Small-cap Short-term Intermediate-term

Stocks Bonds
Median fund in lowest-cost quartile

Median fund in highest-cost quartile
Notes: All mutual funds in each Morningstar category were ranked by their expense ratios as of December 31, 2019. They were then divided into four equal groups, from the lowest-cost to
the highest-cost funds. The chart shows the ten-year average annualized returns for the median funds in the lowest-cost and highest-cost quartiles. Returns are net of expenses, excluding
loads and taxes. Both actively managed and index funds are included, as are all share classes with at least ten years of returns. Data reflect the ten-year period ended December 31, 2019.
Benchmarks reflect those identified in each fund’s prospectus. “Dead” funds are those that were merged or liquidated during the period.
FIGURE 12
Asset-weighted expense ratios of active and index investments
Average expense ratio as of December 31, 2019
Investment type Actively managed funds Index funds ETFs
U.S. stocks Large-cap 0.63% 0.06% 0.11%
Mid-cap 0.81 0.08 0.15
Small-cap 0.83 0.09 0.14
U.S. sectors Industry sectors 0.82 0.42 0.26
Real estate 0.77 0.13 0.18
International stocks Developed market 0.71 0.11 0.17
Emerging market 0.87 0.14 0.27
U.S. bonds Corporate 0.43 0.09 0.10
Government 0.39 0.04 0.11
Notes: “Asset-weighted” means that the averages are based on the expenses incurred by each invested dollar. Thus, a fund with sizable assets will have a greater impact on the
average than a smaller fund. ETF expenses reflect indexed ETFs only. We excluded “active ETFs” because they have a different investment objective from indexed ETFs.
seeks to track a market benchmark, not to exceed it. Although some actively managed
funds have low costs, as a group they tend to have higher expenses. This is because of the
research required to select securities for purchase and the generally higher portfolio turnover
associated with trying to beat a benchmark.7
There is much data to support the outperformance of indexed strategies, especially over
the long term, across various asset classes and sub-asset classes. Figure 13 shows the
percentage of actively managed funds that have underperformed the benchmarks for
common asset categories over the 15 years through 2019. It provides the results in two
ways: first, measuring only those funds that survived for the entire period; and second,
FIGURE 13
Percentage of active funds underperforming their prospectus benchmark over 15 years through December 2019
100%
80
Percentage underperforming
60
40
20
0
–0.89 –0.66 –0.76 –1.72 –0.66 –1.11 –0.22 0.22 –0.12 –0.20 –0.10 –0.02 –0.10 –0.35 –0.25 –0.58 –0.17 –1.12
Blend Growth Value Blend Growth Value Blend Growth Value Dev. Em. Global Corp. Gov’t Corp. Gov’t GNMA High-
mkts. mkts. yield
Large-cap Mid-cap Small-cap Short-term Intermediate-term
Stocks Bonds
Based on surviving funds

Based on survivors plus dead funds
x.xx Median surviving fund excess return (%)
Notes: Data reflect the 15-year period ended December 31, 2019. Fund classifications provided by Morningstar, Inc.; benchmarks reflect those identified in each fund’s prospectus.
“Dead” funds are those that were merged or liquidated during the period.
Value Blend Growth Value Blend Growth Value Blend Growth Gov’t Corp. Gov’t Corp. High-yield
Large-cap Small-cap Short-term Intermediate-term
Based on funds
surviving funds
after 15 years
Based on
7 T urnover, or the buying and selling of securities within a fund, results in transaction costs such as commissions, bid-ask spreads, and opportunity survivors
cost. These costs, which are incurred
by every fund, are not spelled out for investors but do detract from net returns. For example, a mutual fund with abnormally high turnoverplus
woulddead funds
be likely to incur large trading costs. All
else equal, the impact of these costs would reduce total returns realized by the investors in the fund. x.xx Median surviving fund
excess return (%)
including the funds that disappeared along the way.8 The chart shows how difficult it can be
for active managers to outperform index funds. The results are especially telling when they
account for funds that were closed or merged during the 15-year period. Research has shown
that low costs, inherent in passive investing, are a key driver in the long-term outperformance
of indexed portfolios (Rowley et al., 2019).
Tax-management strategies can enhance after-tax returns
Taxes are another potentially significant cost. For many investors, it may be possible to
reduce the impact by allocating investments strategically among taxable and tax-advantaged
accounts. The objective of this “asset location” approach is to hold relatively tax-efficient
investments, such as broad-market stock index funds or ETFs, in taxable accounts while
keeping tax-inefficient investments, such as taxable bonds, in retirement accounts. In the
fixed income markets, tax-sensitive investors with higher incomes can consider tax-exempt
municipal bonds in nonretirement accounts.9
The key takeaway
Investors cannot control the markets, but they can often control what they pay to invest. And
that can make an enormous difference over time. The lower your costs, the greater your share
of an investment’s return, and the greater the potential impact of compounding.
Further, as we have shown, research suggests that lower-cost investments have tended to
outperform higher-cost alternatives.
8 Additional analysis regarding the performance of funds that have been closed was presented in Schlanger and Philips (2013).
9 A n in-depth discussion of asset location was presented in Jaconetti (2007), and a discussion of tax-efficient investing was presented in Donaldson and Kinniry (2008).
Discipline
Maintain perspective and long-term discipline.
Investing can provoke strong emotions. In the face of market turmoil,

some investors may find themselves making impulsive decisions or,
conversely, becoming paralyzed, unable to implement an investment
strategy or rebalance a portfolio as needed. Discipline and perspective
are the qualities that can help investors remain committed to their long-
term investment programs through periods of market uncertainty.
Here we show the benefits of a disciplined approach to investing and the cost
of allowing emotional impulse to undermine it. We provide evidence that:
■■ Enforcing an asset allocation through periodic rebalancing can help manage a
portfolio’s risk.
■■ Spontaneous departures from such an allocation can be costly.
■■ Attempts to outguess the market rarely pay.
■■ Chasing winners often leads to a dead end.
■■ Simply contributing more money toward an investment goal can be a surprisingly
powerful tool.
The case for discipline
Although the asset allocation decision is one of the cornerstones for achieving an objective,
it only works if the allocation is adhered to over time and through varying market environ-
ments. Periodic rebalancing will be necessary to bring the portfolio back in line with the
allocation designed for the objective. In a 2015 paper, Jaconetti, Kinniry, and Zilbering
concluded that for most broadly diversified portfolios, the asset allocation should be checked
annually or semiannually, and the portfolio should be rebalanced if it has deviated more than
5 percentage points from the target.
Of course, deviations resulting from market movements offer an opportunity to revalidate the
targeted asset allocation. However, abandoning an investment policy simply because of these
movements can harm progress toward an objective. Figure 14 shows how an investor’s risk
exposure can grow unintentionally when a portfolio is left to drift during a bull market.
FIGURE 14
The importance of maintaining discipline: Failure to rebalance can increase an investor’s exposure to risk
Changes in stock exposure for a rebalanced portfolio and a “drifting portfolio,” 2003–2019
85%
80 Portfolio never rebalanced
75
Allocation to stocks
70
65
Portfolio rebalanced semiannually
60
Target equity allocation
55
50
45
40
2003 2005 2007 2009 2011 2013 2015 2017 2019
Year
Notes: The initial allocation for both portfolios is 42% U.S. stocks, 18% international stocks, and 40% U.S. bonds. The rebalanced portfolio is returned to this allocation at the end of
each June and December. Returns for the U.S. stock allocation are based on the Dow Jones U.S. Total Stock Market Index. Returns for the international stock allocation are based on the
MSCI All Country World Index ex USA, and returns for the bond allocation are based on the Bloomberg Barclays U.S. Aggregate Bond Index.
It compares the stock exposures of two portfolios—one that is never rebalanced and one
that is rebalanced twice a year—over changing market environments since early 2003.
Both of these hypothetical portfolios start at 60% stocks, 40% bonds, but four years later
the “drifting” portfolio has moved to 75% stocks. That much equity exposure might seem
appealing during a bull market, but by late 2007 the portfolio would have faced significantly
greater downside risk as the financial crisis began.
Figure 15 shows the impact of fleeing an asset allocation during a bear market for equities.
In this example, the investor moves out of equities on February 28, 2009, to avoid further
losses. While the 100% fixed income portfolio experienced less volatility, the investor who
chose to stay with the original asset allocation recovered most completely from the 2009
setback to earn a superior return.
FIGURE 15
The importance of maintaining discipline: Reacting to market volatility can jeopardize returns
What if the “drifting” investor fled from equities after the 2008 plunge and invested 100% in either fixed income or cash?
220 February 28, 2009: –34% Trough to peak

206%
60% Equity/40% Fixed income
180
Cumulative return
140
53%
100 100% Fixed income
6%
100% Cash
60
2008 2010 2012 2014 2016 2018
Notes: October 31, 2007, represents the equity peak of the period, and has been indexed to 100. The initial allocation for both portfolios is 42% U.S. stocks, 18% international stocks, and
40% U.S. bonds. It is assumed that all dividends and income are reinvested in the respective index. The rebalanced portfolio is returned to a 60% stock/40% fixed income allocation at
month-end. Returns for the U.S. stock allocation are based on the MSCI US Broad Market Index. Returns for the international stock allocation are based on the MSCI All Country World
Index ex USA. Returns for the bond allocation are based on the Bloomberg Barclays U.S. Aggregate Bond Index, and returns for the cash allocation are based on the Bloomberg Barclays 3
Month US Treasury Bellwethers.
It’s understandable that during the losses and uncertainties of a bear market in stocks, many
investors will find it counterintuitive to rebalance by selling their best-performing assets
(typically bonds) and committing more capital to underperforming assets (such as stocks).
But history shows that the worst market declines have led to some of the best opportunities
for buying stocks. Investors who did not rebalance their portfolios by increasing their stock
holdings at these difficult times not only may have missed out on subsequent equity returns
but also may have hampered their progress toward long-term investment goals—the target
for which their asset allocation was originally devised.
Ignore the temptation to alter allocations
In volatile markets, with very visible winners and losers, market-timing is another dangerous
temptation. The appeal of market-timing—altering a portfolio’s asset allocation in response to
short-term market developments—is strong. This is because of hindsight: An analysis of past
returns indicates that taking advantage of market shifts could result in substantial rewards.
However, the opportunities that are clear in retrospect are rarely visible in prospect.
Indeed, Vanguard research has shown that while it is possible for a market-timing strategy
to add value from time to time, on average these strategies have not consistently produced
returns exceeding market benchmarks (Stockton and Shtekhman, 2010). Vanguard is not alone
in this finding. Empirical research conducted in both academia and the financial industry has
repeatedly shown that the average professional investor persistently fails to time the market
successfully. Figure 16, on page 28, lists nine studies making this point, starting in 1966,
when J.L. Treynor and Kay Mazuy analyzed 57 mutual funds and found that only one showed
significant market-timing ability.
FIGURE 16
Casualties of market-timing Asset allocation funds Becker et al. 1999
These are groups found to have failed,
Investment clubs Barber and Odean 2000
on average, to successfully time the
markets, along with the researchers
Pension funds Coggin and Hunter 1983
responsible for the findings. (All the
studies are listed in the References.) Investment newsletters Graham and Harvey 1996
Mutual funds Chang and Lewellen 1984
Henriksson and Merton 1981
Kon 1983
Treynor and Mazuy 1966
Professional market-timers Chance and Hemler 2001
Figure 17 looks at the performance of active equity funds during various expansionary
and recessionary periods since 1990. Presumably, most such funds are run by sophisticated
investment managers with data, tools, time, and experience on their side. Generally speaking,
their common objective is to outperform a benchmark in any market environment, whether
through security selection or through well-timed increases and reductions in equity exposure.
The figure shows the performance of actively managed funds in seven distinct periods,
four expansionary and three recessionary. We compare them against their stated
prospectus benchmark.
An important conclusion can be drawn from this analysis: In only one period did a majority of
the actively managed funds outperform their prospectus benchmark. The lesson? If market-
timing is difficult for professional managers with all their advantages, investors without such
advantages should think twice before altering a thoughtfully designed portfolio.
As Figures 16 and 17 show, the failure of market-timing strategies has not been limited to
mutual funds. Investment newsletters, pension funds, investment clubs, and professional
market-timers have also failed to demonstrate consistent success. Why is success so elusive?
In a word—uncertainty. In reasonably efficient financial markets, the short-term direction
of asset prices is close to random. In addition, prices can change abruptly, and the cost of
mistiming a market move can be disastrous.
FIGURE 17
Active managers have struggled to beat market benchmarks in expansions and recessions
Percentage of U.S. active equity managers underperforming during various business cycles
100%
80
60
40
20
0
Expansion Recession Expansion Recession Expansion Recession Expansion
1/1990– 7/1990– 4/1991– 3/2001– 12/2001– 12/2007– 7/2009–
6/1990 3/1991 2/2001 11/2001 11/2007 6/2009 12/2019
Notes: Benchmarks reflect those identified in each fund’s prospectus. Funds that were merged/liquidated were treated as underperformers for purposes of this analysis.
Sources: Vanguard calculations, using data from Morningstar, Inc., and the National Bureau of Economic Research.
Ignore the temptation to chase last year’s winner
Another component of performance chasing has to do with investment managers

themselves. For years, academics have studied whether past performance has any predictive
power regarding future performance. Researchers dating back to Sharpe (1966) and Jensen
(1968) have found little or no evidence that it has. Carhart (1997) reported no evidence of
persistence in fund outperformance after adjusting for the common Fama-French risk factors
(size and style) as well as for momentum. More recently, in 2010, Fama and French’s
22-year study suggested that it is extremely difficult for an actively managed investment
fund to regularly outperform its benchmark.
Figure 18 demonstrates the challenge of using past success as a predictor of future success.
To test if active managers’ performance has persisted, we looked at two separate, sequential,
non-overlapping five-year periods. First, we ranked the funds by performance quintile in the
first five-year period, showing the top 20% of funds going into the first quintile. Second, we
sorted those funds by performance quintile according to their performance in the second five-
year period. To the second five-year period, however, we added a sixth category: funds that
were either liquidated or merged during that period.
We then compared the results. If managers were able to provide consistently high
performance, we would expect to see the majority of first-quintile funds remaining in the
first quintile. Figure 18, however, shows that a majority of managers failed to remain in the
first quintile.10
It is interesting to note that, once we accounted for closed and merged funds, persistence
was actually stronger among the underperforming managers than those that outperformed.
These findings were consistent across all asset classes and all markets we studied globally.
From this, we concluded that consistent outperformance is very difficult to achieve. This
is not to say that there are not periods when active management outperforms, or that no
active managers do so regularly. Only that, on average and over time, active managers as a
group fail to outperform; and even though some individual managers may be able to generate
consistent outperformance, those active managers are extremely rare.
10 We define consistently high performance persistence as maintaining top quintile excess return performance. It should, however, be noted that a manager may fall below the top
quintile when measured against peers, but still generate positive outperformance versus a benchmark. Of course, it could also be the case that a manager remains in the top quintile
but does not generate outperformance versus a benchmark.
FIGURE 18
Fund leadership is quick to change
Top quintile
How the top-performing stock funds of 2014 20.8% Remained in top quintile
fared in the rankings five years later

2nd quintile
16.1% Fell to 2nd quintile
3rd quintile
11.0% Fell to 3rd quintile
4th quintile 14.3% Fell to 4th quintile
5th quintile 13.7% Fell to bottom quintile
24.1% Merged/liquidated
Notes: Vanguard ranks all active U.S. equity funds within each of the 9-style Morningstar categories based on their excess returns relative to their stated benchmark during the five-year
period as of December 31, 2014. The columns show how funds in the first quintile performed over the next five years; we added a category for funds that were merged or liquidated.
Market-timing and performance chasing can be a drag on returns
A number of studies address the conceptual difficulties of market-timing. Some examine the
records of professional market-timers. The results are discouraging for proponents of market-
timing. But what about the experience of the typical investor? Has timing been a net positive
or negative?
Another way to analyze managed fund investor behavior is to compare investor returns
(internal rates of return, or IRRs) to a fund’s reported total returns (time-weighted returns, or
TWRs). Fund TWRs represent the performance of a mutual fund’s assets under management
for a defined period of time and are generally the industry standard for reporting returns. IRRs
approximate the returns earned by the average dollar invested in the fund over the same
period, rather than the result of any specific investor.
The two results tend to differ to various degrees and in various directions. The IRR differs
from the TWR because of cash flows in and out of the fund; absent any cash flows, the TWR
and IRR should be the same. All managed funds should expect a return drag versus their
benchmark over longer periods as money continually enters a rising market.
However, larger differences can be a sign of performance chasing (Kinniry and Zilbering,
2012). Investors and the funds they invest in commonly receive much different returns (see
Figure 19).11 For the ten-year period ended December 31, 2019, investors received lower
returns than the funds they invested in, demonstrating that these funds’ cash flows tended
to be attracted rather than followed by higher returns. History suggests that, on average,
this gap is most evident in fund categories that are more concentrated, narrow, or different
from the overall market. It is less negative in the more broadly diversified categories, which
typically include a varying mix of equity and fixed income.
FIGURE 19
Investor returns versus fund returns: Ten years ended December 31, 2019
When investors chase performance, they often get there late
0%
Average annual difference between investor
return and fund return (percentage points)
–0.40% –0.43%
–0.5
–0.60% –0.62%
–0.66%
–0.70%
–0.79%
–0.82%
–0.88%
–1.0
–1.08%
–1.18%
–1.5
*Moderate **Cautious Value Growth Blend Value Growth Blend Value Growth Blend
Small-cap Mid-cap Large-cap

Allocations Equities
Notes: The time-weighted returns in this figure represent the average fund return in each category. Investor returns assume that the growth of a fund’s total net assets for a given period
is driven by market returns and investor cash flow. An internal rate-of-return function calculates the constant growth rate that links the beginning total net assets and periodic cash flows
to the ending total net assets. Discrepancies in the return difference are due to rounding. Fund categories include fund-of-fund assets and cash flows to best capture investors’
experience when that structure is common.
* Moderate Allocation portfolios typically have 50% to 70% of assets in equities and the remainder in fixed income and cash.
** Cautious Allocation portfolios typically have 20% to 50% of assets in equities and 50% to 80% of assets in fixed income and cash.
11 For more on IRR/TWR see Kinniry, et al. (2019).
Saving/spending > Market performance
Increasing the savings rate can have a substantial impact on wealth accumulation (Bruno
and Zilbering, 2011). To meet any objective, one must rely on the interaction of the portfolio’s
initial assets, the contribution or spending rate over time, the asset allocation, and the
return environment over the duration of the objective. Because the future market return is
unknowable and uncontrollable, investors should instead focus on the factors that are within
their control—namely asset allocation and the amount contributed to or spent from the
portfolio over time.12
Figure 20 shows a simple example of the power of increasing contribution rates to meet a given
objective. For this example we have an investor who has a goal of $500,000 (in today’s dollars
adjusted for inflation), invests $10,000 to start, and—in the baseline case—contributes $5,000
each year (without adjusting for inflation). The example shows varying rates of market return.
FIGURE 20
Increasing the savings rate can dramatically improve results
Years needed to reach a target using different contribution rates and market returns
$500,000 10% annual savings increases

8% return
4% return
400,000
5% annual savings increases
8% return
300,000 4% return
No savings increases
200,000 8% return
4% return
100,000
0
0 10 20 30 40 50 60 70
Years
Notes: The portfolio balances shown are hypothetical and do not reflect any particular investment. There is no guarantee that investors will be able to achieve similar rates of return. The
final account balances do not reflect any taxes or penalties that might be due upon distribution.
Source: Vanguard.
12 It is also essential to control costs—another cornerstone of Vanguard’s investment philosophy. The time horizon may or may not be within the investor’s control.
The first set of two scenarios assumes that the contribution level is steady, with the investor
relying more heavily on the markets to achieve the target. Simply increasing the contribution
by 5% each year ($5,250 in year 2, $5,512 in year 3, etc.) or 10% per year significantly
shortens the time needed to meet the $500,000 objective. Note that getting an 8% return
while increasing savings by 5% a year produces almost the same result as getting a 4% return
while boosting savings by 10% a year. In real-world terms, the big difference in those two
scenarios is risk: An investor pursuing an 8% long-term return would most likely be forced
to take on much more market risk than someone looking for 4%.
This reinforces the idea that a higher contribution rate can be a more powerful and reliable
factor in wealth accumulation than trying for higher returns by increasing the risk exposures
in a portfolio.
The key takeaway
Because investing evokes emotion, even sophisticated investors should arm themselves
with a long-term perspective and a disciplined approach. Abandoning a planned investment
strategy can be costly, and research has shown that some of the most significant derailers
are behavioral: the failure to rebalance, the allure of market-timing, and the temptation to
chase performance.
Far more dependable than the markets is a program of steady saving. Making regular
contributions to a portfolio, and increasing them over time, can have a surprisingly powerful
impact on long-term results.
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and Yan Zilbering, 2015. Best Practices for
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Portfolio Rebalancing. Valley Forge, Pa.: The
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Hoax. Journal of Financial Planning 10(1): 109–13. The Vanguard Group.
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Kinniry, Francis M Jr., Colleen M. Jaconetti, An Analysis of ‘Go-Anywhere Funds.’
Michael A. DiJoseph, Yan Zilbering, and Donald Valley Forge, Pa.: The Vanguard Group.
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Stockton, Kimberly A., and Anatoly Shtekhman,
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Vanguard’s

investment philosophy, and Vanguard is no different. Although we offer many

specific strategies through both internally and externally managed funds, an

overarching theme runs through the investment guidance we provide to clients—

focus on those things within your control.

performance of an individual security or strategy, overlooking the fundamental

future—enduring principles that guide the investment decisions we help our

Balance Develop a suitable asset

Cost Minimize cost. 17

Discipline Maintain perspective

Create clear, appropriate investment goals.

An appropriate investment goal should be measurable and attainable.

■■ Recognizing constraints, especially those that involve risk-taking, is essential to

developing an investment plan.

■■ Without a plan, investors can be tempted to build a portfolio based on transitory

Objective Save $1 million for retirement, adjusted for inflation.

Constraints 30-year horizon.

Current portfolio value: $50,000.

Monthly net income of $4,000; monthly expenses of $3,000.

Effect of taxes on returns.

Saving or spending target Willing to contribute $5,000 in the first year.

Allocations to foreign investments as appropriate.

Rebalancing methodology Rebalance annually.

The danger of lacking a plan

Mean performance of Fund ratings

(in percentage points)

Morningstar rating –1.5

Cash flows for Morningstar- $200

Develop a suitable asset allocation using broadly diversified funds.

A sound investment strategy starts with an asset allocation suitable for

■■ A diversified portfolio’s proportions of stocks, bonds, and other investment types

determine most of its return as well as its volatility.

■■ Attempting to escape volatility and near-term losses by minimizing stock

■■ Realistic return assumptions—not hopes—are essential in choosing an allocation.

■■ Leadership among market segments changes constantly and rapidly, so investors

must diversify both to mitigate losses and to participate in gains.

When building a portfolio to meet a specific objective, it is critical to select a combination

Security selection a nd market timing 8.9%

Asset allocation 91.1%

Annual returns 60% 54.2%

U.S. stocks Non-U.S. stocks U.S. bonds Non-U.S. bonds Other

In practice, diversification is a rigorously tested application of common sense: Markets will

Worst performers Return Best performers Return

Washington Mutual, Inc. –99.39 UST Inc. 31.96

American International Group, Inc. –97.25 H&R Block, Inc. 25.77

General Growth Properties, Inc. –96.49 Amgen Inc. 24.35

Fannie Mae –96.06 Barr Pharmaceuticals, Inc. 23.92

Freddie Mac –94.87 Synovus Financial Corp. 23.40

Ambac Financial Group, Inc. –94.75 Wal-Mart Stores, Inc. 20.00

XL Capital Ltd. (Class A) –92.15 Celgene Corp. 19.63

American Capital, Ltd. –89.05 Rohm and Haas Co. 19.44

National City Corp. –88.75 Hasbro, Inc. 16.82

Sources: Vanguard and FactSet.

To show why it is essential to consider cost when choosing investments,

■■ Indexed investments can be a useful tool for cost control.

Reduce cost to help improve return

Distribution of investor returns Distribution of investor returns

Lower return Higher return

Indexing can help minimize costs

To show why it is essential to consider cost when choosing investments,