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Why Invest With Vanguard?
Marnie Aznar, November 2003

In the wake of the scandals rocking the mutual fund industry, the importance of investing with a mutual fund company that has the best interests of their individual shareholders at heart has become exceedingly clear. The Vanguard Group has and continues to be known for its fiduciary responsibility, ethics, and integrity.

Vanguard has long had a variety of measures in place to discourage harmful trading activity and protect long-term shareholders. These measures include (among others) strict trading restrictions, early redemption fees, fair value pricing, and candid communications with their shareholders. Additionally, as the average expense ratio on mutual funds has increased nearly 24% to 1.36% over the past seven years, Vanguard's average expense ratio has dropped 16% to 0.26% during the same time period. (Source: Lipper Inc.)

Vanguard is well known for its index funds. Index funds or "passively" managed funds do not try to beat the market. Instead, these funds seek to mirror the performance of a target market index. Index funds buy and hold all (or a representative sample) of the securities in the index. Index funds are typically the lowest cost, lowest risk, and most consistent performers in the mutual fund universe. They are widely diversified, stay fully invested, keep costs to a bare minimum, avoid style drift, and generate the lowest tax consequences to their owners.

There is no evidence that active management increases returns over a passive buy and hold strategy. The data overwhelmingly shows that over time attempts to select individual stocks or time the market under perform the appropriate benchmark. Clearly, some funds will always beat the benchmark, but this eventuality is dictated by pure chance. These funds are seldom the same funds from one period to the next, and unfortunately it is impossible to know which ones they are in advance.

We therefore recommend the following three Vanguard index funds as a sound core to any individual investor's portfolio:

1. Vanguard Total Stock Market Index (Ticker: VTSMX)
This is an excellent choice for low-cost exposure to the broad stock market. It is difficult to beat the wide diversification, incredibly low expenses and high tax efficiency that this fund offers. Thanks in large part to the fund's low cost structure the fund's long-term returns are excellent.

2. Vanguard Total International Stock Index (Ticker: VGTSX)
This fund is composed of Vanguard's three regional index funds: Vanguard European Stock, Vanguard Pacific Stock, and Vanguard Emerging Markets Stock. This fund has outperformed most actively managed rivals since 2000 and its five-year return bests about two thirds of the foreign large-blend category. Low costs and wide diversification make this fund of funds an excellent choice.

3. Vanguard Short-Term Bond Index (Ticker: VBISX)
Like many of Vanguard's index funds, this fund's low costs and wide diversification have paved the way to very good relative returns. The fund's five-year annualized gain of 6.2% bests the majority of its short-term bond category rivals. Given the likelihood of increasing interest rates over the next few years, bond investors would be well served by choosing short and intermediate term fixed income investments as opposed to long-term investments which will be more heavily negatively impacted by rising rates.

Full Disclosure: AFA and some of AFA's clients are invested in these funds.

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