When I bought my first car, my budget was a little . . . strained. After doing the research and test-driving a few models, I made my choice. The car was simple, reliable, and affordable. A hundred thousand miles later, my modest investment had delivered on its promise to get me where I wanted to go. I still think about that car with a fair amount of nostalgia because it proved a better buy than those I purchased later. It was also my first introduction to the cost-value paradox where what you pay and what you get in return can be markedly different.

Vanguard investors know this paradox well. It’s why many of our clients come to Vanguard, and it’s why even more of them stay for the long term. They understand that when you pay less for an investment, you get to keep more of its return. The research bears this out: Fees are the most consistent and effective predictor of long-term performance.

Lower costs have meant higher net returns

10-year annualized return by quartile: As of 12/31/2015

Blog_Martha_bar_06062016

Source: Vanguard, using data from Morningstar. Past performance is no guarantee of future returns.

But low cost doesn’t always mean better value. If I think of all the low-cost cars I could have purchased, many of them wouldn’t have made it to my college graduation. They were cheap for a reason—some had high mileage, some had reliability issues, and some were bare bones when it came to amenities. The melding of low expenses and high quality is the key to the cost-value paradox.

When evaluating the value of active investments, I tell clients to consider two factors: cost and outperformance. It’s a straightforward formula that requires considerable effort to get right because long-term outperformance is often elusive. Beating the benchmark over the course of one or two years could be the product of skill or luck, depending on the circumstances. When we talk about a winning active strategy at Vanguard, the time horizon is much longer. Over the past ten years, 92% of our funds have outperformed their peer-group averages, which is a testament to the expertise, skill, and judgment of our teams.

Long-term outperformance

Blog_Martha_donuts_06062016

For the one-year period ended December 31, 2015, 81% of Vanguard funds outperformed their peer-group averages. For the three-year period ended December 31, 2015, 88% of Vanguard funds outperformed their peer-group averages. For the five-year period ended December 31, 2015, 87% of Vanguard funds outperformed their peer-group averages. For the ten-year period ended December 31, 2015, 92% of Vanguard funds outperformed their peer-group averages. Results will vary for other time periods. Only funds with a minimum one-, three-, five-, or ten-year history, respectively, were included in the comparison. (Source: Lipper, a Thomson Reuters company.) Note that the competitive performance data shown represent past performance, which is not a guarantee of future results, and that all investments are subject to risks. For the most recent performance, visit our website at www.vanguard.com/performance

 

Indexing requires just as much skill, but value is measured in a different way. Portfolio managers must tightly track their fund’s benchmark while managing tax efficiency, cash flow, and changes to the index. On the surface, indexing may seem simple. Look closely and you’ll get a sense of the sophistication and talent needed to approximate a benchmark return with minimal tracking error while keeping costs low. It’s not easy, yet our teams consistently meet the challenge year in and year out.

Underlying this work are the benchmarks themselves, which deserve just as much consideration. In 2012, we made the decision to transition more than 20 of our funds and ETFs to new benchmark providers. It was a decision that invited scrutiny, but it was the right one for continuing to drive down costs for our investors and the industry at large. While we may be known for our passive investing products like indexing, we’ll never be passive in our approach to giving clients the best chance for investing success.

Economies of scale and strategic investments continue to propel us forward. As more clients entrust us with their assets, we’re able to invest in the talent, technology, and research that keep our funds consistently competitive. At the same time, we’re able to return savings back to our clients in the form of lower expense ratios. It’s the cost-value paradox at its best.

Vanguard is known as a low-cost provider, and we wear that title proudly. Keeping costs low can help generate higher returns for investors. But don’t let low costs be the only factor driving your decision about which funds to include in your lineup. Look under the hood and determine what exactly you’re getting for every basis point.

Note: All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.