Chairman's Corner: The Return of Simplicity
The Vanguard Group  

As I finish my 25th year at Vanguard, I marvel at how simple it is today to implement a prudent long-term investment program. When I joined Vanguard, however, simplicity seemed to be on its way out. Long-established balanced portfolios such as Vanguard® Wellington™ Fund and Vanguard Wellesley® Income Fund—the precursors of today's life-cycle funds—were experiencing significant redemptions. In fact, in 1981 shareholders made net withdrawals from Wellington Fund equal to 16% of fund assets. In Wellesley, the figure was 17%.

Why invest in a single balanced fund, the thinking seemed to be, when you could combine the world's greatest small-cap value manager, the best long-term corporate bond manager, and so on, to create your own diversified portfolio? This "unbundled" approach makes some sense in theory, but the execution is devilishly hard.

Maybe that's why investors are rediscovering simplicity. Or maybe in the rush of daily life, people are simply placing a higher premium on low-maintenance strategies that can help them reach their goals. In this Chairman's Corner, I'll review the trend toward—and highlight the benefits of—simplified investing.

The reemergence of the balanced fund
The reemergence of the balanced fund is a clear sign that simplicity is in the ascendant. During the mid-1990s, cash flows into balanced funds accounted for a small share of the net cash flows into all long-term mutual funds (stock, bond, and balanced). As the stock market peaked in 1999 and 2000, investors abandoned these simple portfolios, snapping up tech-heavy growth funds and narrowly focused plays on the dot-com boom.


Source: ICI and Vanguard. Net cash flows into hybrid funds as a percentage of cash flows into long-term funds.

In the wake of the stock market's collapse, purchases of balanced funds soared. In fact, the chart above understates the reemergence of the balanced fund; it excludes life-cycle funds-of-funds such as Vanguard Target Retirement Funds—portfolios of stocks and bonds that become more conservative as their target date approaches—which have been attracting significant cash flow. Decide when you expect to retire, purchase a fund with the corresponding date, and you've addressed most of your major investment decisions—simplicity itself.

Launch of the autopilot defined-contribution plan
Simplicity is also reasserting itself within employer-sponsored retirement plans. Congress and the Department of Labor have encouraged employers to adopt so-called autopilot 401(k) plans. Employees are automatically enrolled in the plan, their contributions are invested in a balanced or life-cycle fund appropriate for retirement saving, and their level of contribution is increased each year.

Contrast the autopilot plan with the traditional approach. An employee must decide whether to join the plan, how much to contribute, which investments to select—potentially thousands of choices—and whether contribution levels should be changed periodically. It's a series of complex and nerve-racking decisions, particularly for novice investors. Too often, the result has been poor decisions or, worse, no decision at all.

Fewer decisions means better decisions
Simplicity can't be an end in itself, of course. Simplicity is valuable only if it gives us a better chance of reaching our investment goals. Although it's impossible to prove that a complex approach is unproductive, academic research and investor behavior suggest that complexity preys on tendencies that can do a lot of damage to our portfolios.

• Performance chasing. Investors' tendency to chase returns is well-documented. Here's an eye-opening example: From 1995 to 2005, volatile technology funds generated an annualized return of 6.9%. But the typical shareholder in these funds earned an "investor return"—a figure that adjusts fund performance for the timing of purchases and sales—of only 4.4%, according to Morningstar. Investors did a poor job of timing their transactions, capturing only 64% of what the funds produced. The regular and investor returns of balanced (moderate allocation) funds—7.5% and 7.3%—suggest that balanced-fund shareholders were less susceptible to performance chasing and, on average, captured almost all (98%) of their funds' returns.
• Paralysis in the face of choice. Choice is good, but too many choices can be debilitating. Researchers at Columbia University have found that as retirement-plan sponsors add more investment options, participation in the plan declines. Although the effect was modest, it echoes findings from other research about consumer decisions.

I wonder whether these findings can help explain the rapid growth of Vanguard's financial planning services. Many of our planning clients are longtime investors who have established complex portfolios. On average, they come to us with 23 holdings, including mutual funds, individual stocks and bonds, and other assets. Some come in with more than 200 investments. If they needed to act, which of the 200 levers would they pull?

Simple recipes for wealth creation
I like to cite two real-world examples of the power of simplified investing, one from our own history and one from the media: Vanguard Wellington Fund and "The Couch Potato Portfolio," the creation of personal finance columnist Scott Burns.

Suppose a distant relative had invested $1,000 in Wellington Fund when it opened for business on July 1, 1929. Over the next 77 years, the fund followed the same balanced strategy. Your relative made no other investment decisions. Today, that initial investment would be worth more than $520,000—an annualized return of 8.4% and an increase in real (that is, inflation-adjusted) purchasing power of more than 49 times.

Scott Burns' original Couch Potato Portfolio consisted of 50% Vanguard 500 Index Fund and 50% Vanguard Total Bond Market Index Fund—so simple it could be managed from the couch with one hand on the remote and the other in the pretzel bowl. From 1992 to 2005, the portfolio returned 8.7% per year. You could have spent many hours trying to create a similarly weighted portfolio from the multitude of stock and bond funds at your fingertips, but you would have earned, on average, almost 1 percentage point less, according to data from Lipper Inc.

Note: The performance data cited represent past performance, which is not a guarantee of future results. Investment returns will fluctuate. Current performance may be lower or higher than the performance data cited. You can view funds' current month-end performance data and standardized performance (1-, 5-, and 10-year returns) in Research Funds & Stocks.

New Year's resolutions
Clients sometimes tell me that Vanguard has contributed to investment complexity by offering so many mutual funds. It's a fair point, but I explain that Vanguard has millions of institutional and individual clients, some with unique circumstances and special needs. We work hard to serve all of them. But for most of us, simplicity is hard to beat.

If you're inclined to make New Year's resolutions, take a look at your own investment program. Are there opportunities to simplify? Don't forget account administration, either. The tools on Vanguard.com® make administrative tasks that once required hours of labor and reams of paper and postage as simple as the click of a mouse.


Notes

All investments are subject to risks, including possible loss of principal. Investments in bonds are subject to interest rate, credit, and inflation risk. Past performance is not a guarantee of future returns. Diversification does not ensure a profit or protect against a loss in a declining market, including possible loss of principal.
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.
Vanguard Target Retirement Funds are subject to the risks associated with their underlying funds.