Vanguard s economic and investment outlook

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1 Vanguard s economic and investment outlook Joseph Davis, Ph.D. Roger Aliaga-Díaz, Ph.D. Andrew J. Patterson, CFA This annual global outlook presents Vanguard s perspectives on future growth, inflation, interest rates, and long-range returns from stocks and bonds. The situation: Global growth remains uneven, while chronic fiscal imbalances and sovereign debt/banking issues continue to cause concern in capital markets. The question: What are reasonable expectations for economic growth and future long-term returns from stocks and bonds? Vanguard conclusion: U.S. growth is likely to remain muted. Projected ten-year stock and bond market returns are centered in a range below historical averages, although global equities have a 50% likelihood of realizing their long-term inflationadjusted average. Expected risk return trade-offs affirm Vanguard s principles of portfolio construction. This article discusses Vanguard s view on the potential range of risk premiums that may occur over the next ten years from the perspective of a U.S. investor with a dollardenominated portfolio. Our long-term projections are not intended to be extrapolated to a short-term view of the next 12 months. Potential outcomes for long-term investment returns are generated by the Vanguard Capital Markets Model 1 and reflect the collective perspective of our Investment Strategy Group. Secular growth outlook Over the decade ending 2022, global expansion should occur at varied speeds, with emerging markets and Australia generally expanding fastest, the United States growing more modestly, and Europe, the United Kingdom, and Japan on balance posting more sluggish growth. Since this uneven recovery scenario is broadly priced in by the financial markets, it should have little impact on the projected stock returns in these regions. The U.S. economic recovery is likely to persist at a reduced pace of 2% real gross domestic product (GDP) growth, compared with the historical long-term growth rate of 3.5% 4.0%. Despite this below-average growth rate, our long-range U.S. economic outlook remains more cautiously optimistic than bearish. It is important to note that U.S. profit margins and corporate balance sheets are strong and productivity is high, thereby providing a level of shock-resistance to the U.S. private sector going forward. Progress has also been made to date in reducing consumer debt and, especially, housing imbalances. Indeed, the U.S. housing market appears to have bottomed, and housing construction could Note: This article is adapted from a January 2013 Vanguard research paper by the same authors and title; available at vanguard.com/outlook See descriptions of the VCMM on pages 2 and. 1

2 Key terms Price/earnings ratio. The ratio of a stock s current price to its per-share earnings over a designated period. Risk premium. The amount by which an asset s expected return exceeds the risk-free interest rate. be the fastest-growing segment of the U.S. economy in That said, we anticipate that it will be some time before consumer and U.S. government debt levels, as well as housing prices, reach their longer-term equilibrium levels, a critical condition for sustained above-trend economic growth. On balance, Vanguard views the risk to this long-range outlook as even-keeled. Over the next several years, primary risk factors that would contribute to lower-thanexpected growth include a significant shift in long-term inflation expectations, a breakup of the European Union, and failure by the U.S. government to propose and enact a credible plan to address the nation s long-term fiscal imbalances. 2 Alternatively, prospects for better-than-expected growth could be driven by marked increases in capital investment sparked by the widespread adoption of costsaving technologies, increased housing and infrastructure spending following a prolonged period of depressed activity, substantial U.S. energy independence, and a lower trade deficit. Outlook for inflation As stated in previous Vanguard outlooks, trend inflationary pressures in the United States and most other developed markets are, at present, modest. The recent patterns in key core inflation drivers such as labor costs, inflation expectations, economic slack, and the velocity of money suggest that core U.S. inflation is likely to remain within its recent range of 1.5% 3% over the next one to two years. Over the next ten years, our simulations project a median inflation rate averaging close to 2% per year for the U.S. Consumer Price Index (see Figure 1, on page 3). The expected central inflation range of 1.5% 3% is roughly consistent with the Federal Reserve s long-term goal of inflation stability and is also near longer-term break-even inflation rates in the Treasury Inflation- Protected Securities (TIPS) market. Important: The projections or other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time. The VCMM projections are based on a statistical analysis of historical data. The asset-return distributions shown in this article are drawn from,000 VCMM simulations based on market data and other information available as of November 30, Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based. For more information on the VCMM, please see page. The long-term returns for our hypothetical portfolios are based on data for the appropriate market indexes. For U.S. bond market returns, we used the Standard & Poor s High Grade Corporate Index from 1926 through 1968; the Citigroup High Grade Index from 1969 through 1972; the Lehman Brothers U.S. Long Credit AA Index from 1973 through 1975; and the Barclays U.S. Aggregate Bond Index thereafter. For U.S. stock market returns, we used the S&P 90 Index from 1926 through March 3, 1957; the S&P 500 Index from March 4, 1957, through 1974; the Dow Jones Wilshire 5000 Index from 1975 through April 22, 2005; and the MSCI US Broad Market Index thereafter. For international stock market returns, we used the MSCI EAFE Index from 1970 through 1988, and a blend of 75% MSCI EAFE Index/25% MSCI Emerging Markets Index thereafter. 2 As stressed in our 20 outlook, we would not be surprised if the next global recession were spawned by a fiscal crisis in a major economy (Davis, Wallick, and Aliaga-Díaz, 20). Ultimately, the most effective solution to the problem of government debt levels involves a credible commitment to fiscal austerity through a combination of reduced government spending and higher tax rates. Of course, how preemptive the U.S. Congress will be in addressing such issues is a critical risk factor going forward. 2

3 Figure 1. Projected U.S. CPI inflation rate, VCMM-simulated distribution of expected annualized ten-year CPI inflation rates 40% Probability Median inflation rate, : 3.1% Median inflation rate, : 2.6% -year TIPS break-even inflation rate (as of December 31, 2012): 2.5% 0 1% or less 1% to 0% 0% to 1% 1% to 3% 3% to 4% 4% or more Note: Data as of November 30, Sources: Vanguard and Moody s Investors Service DataBuffet. Outlook for U.S. interest rates Federal Reserve policy In the short term, the long end of the U.S. Treasury yield curve is expected to remain depressed, given the likelihood that the Federal Reserve will keep monetary policy on hold at least through early Based on the distribution of outlooks for U.S. real GDP growth and inflation from the Federal Reserve Bank of Philadelphia s 2012 Survey of Professional Forecasters, our calculations suggest that the Federal Reserve is more likely to keep the federal funds target rate near 0% into 2015 than to raise rates preemptively before mid Further quantitative easing (QE) is likely in 2013 in a continuing effort to minimize recession risk, although we would view such an action as conditional on longer-term inflation expectations dropping meaningfully below 2.5% (as they did before QE1, QE2, and QE3). Cash and money market returns With the yield on the 3-month Treasury bill currently near 0% and the prospects for an extended period of a near-0% federal funds rate, the expected median return on cash is likely to average less than 2% in nominal terms over the next ten years. The real (inflation-adjusted) shortterm interest rate should remain negative for some time, an unfortunate headwind for savers in the years ahead. U.S. Treasury yield curve Consistent with the current depressed nature of the Treasury yield curve, our ten-year projections generally exhibit a gradual rising-rate bias, although the estimated risk of a sharp, imminent rise in long-term U.S. Treasury yields remains low in Based in part on our inflation and Federal Reserve outlook, we expect the yield on the -year Treasury bond to remain near its current range of 1.5% 3.0% for several years before normalizing toward the 3.5% 4.5% range over the next decade, a central tendency near its historical long-run average. 3 Asset-class outlook: Bonds Indicative of the low nominal and real interest rate environment, the expected returns on fixed income portfolios are well below those realized over the past several decades. The central tendency for the expected annualized return on the broad taxable U.S. fixed income market over the next ten years is only 1% 2%. As such, the expected long-run median return is near current benchmark yields and thus most closely resembles the historical bond returns of the 1950s and 1960s (see Figure 2, on page 4). According to our median simulation scenario, wider-than-average risk premiums for corporate bonds partially offset rising Treasury yields. Because of the low yield to maturities on most bond portfolios, the risk of a negative annual bond return over the next several years is elevated. 3 For reference, the average -year U.S. Treasury yield for the years 1800 through December 31, 2012, has been 4.9%. Since 1900, the -year Treasury has yielded 4.7%. (Sources: Federal Reserve and Global Financial Data.) 3

4 Despite the muted outlook for broad bond market returns, it s important to stress that we expect the key benefits of fixed income investing diversification and income to remain in the years ahead. The median correlation between the returns on U.S. bonds and U.S. stocks is expected to be low, with a coefficient of approximately In addition, the downside risk to U.S. fixed income returns over the full forecast horizon is less pronounced than the risk to U.S. equity returns. That said, high-quality bonds may very well not provide the same magnitude of diversification benefits to negative equity returns during flight-to-quality episodes, given the low level of interest rates. Asset-class outlook: Global equities Centered in the 6% 9% range, the long-term median return for global equity markets is modestly below the historical average as a result of current market valuations and the projected equity risk premium. But when this figure is adjusted for potential future inflation, we estimate a 50% likelihood that over the decade , a global equity portfolio will earn at least the 6% average annualized real return observed since Figure 3, on page 5, shows the projected distribution of annualized ten-year U.S. stock returns. This outlook may surprise some readers, considering the global economic outlook. However, our long-held view is that market valuations generally correlate with future stock returns and that consensus economic growth expectations do not. 4 In fact, a positive realized future equity risk premium has tended to correlate with conditions similar to those of today: somewhat normal market valuations, heightened macroeconomic uncertainty, and higher perceived risk aversion. A wildcard in our global equity outlook is the strong influence that monetary and fiscal policy decisions will have on the economy and financial markets in the years ahead. Outlook for international stocks The projected distribution for international equities is not unlike that for U.S. equities, with similarly wide-tail outcomes. The expected return differential between U.S. and non-u.s. equity portfolios is not statistically significant Figure 2. Projected total U.S. bond market returns VCMM-simulated distribution of expected annualized nominal ten-year returns 30% 25 Probability Historical nominal bond returns : 5.5% : 3.1% : 8.1% : 5.9% 5 0 Less 0.5% to 1% 1% to 1.5% 1.5% to 2% 2% to 2.5% 2.5% to 3% 3% to 3.5% 3.5% or more Geometric returns for broad U.S. bond market Note: Data as of November 30, Source: Vanguard. 4 As discussed in previous Vanguard research, including Davis, Aliaga-Díaz, and Thomas (2012), consensus macro expectations tend to be priced in by markets and so have effectively zero correlation with future stock returns over both short and longer-term investment horizons. 4

5 Figure 3. Projected total U.S. equity returns VCMM-simulated distribution of expected annualized nominal ten-year returns 20% Probability 15 Historical nominal equity returns : 9.9% : 9.7% :.1% : 3.5% 5 0 Less 0% to 3% 3% to 6% 6% to 9% 9% to 12% 12% to 15% 15% to 18% 18% or more Geometric returns for broad U.S. stock market Note: Data as of November 30, Source: Vanguard. under most VCMM scenarios, in part because valuations across broad geographic areas of the global equity market are similar as well (see Figure 4, on page 6). We expect the diversification properties of international investing to persist in the future, despite the higher correlations observed between U.S. and international equity markets since the global financial crisis. A strategic allocation to emerging markets in a global equity portfolio is a sound investment strategy based on the principle of diversification. That said, Vanguard continues to caution against significantly overweighting emerging markets solely because the investor subscribes to the widely held view that emerging markets will grow faster than developed economies over the next few years. 5 It should be noted that emerging-market equities in 2011 significantly underperformed U.S. stocks, despite posting higher aggregate economic growth rates. Looking ahead, the expected central range of long-run returns on emerging-market equities is statistically similar to that of developed-market equities when adjusted for emerging markets higher expected volatility. As shown in Figure 4, differences were negligible between the price/ earnings (P/E) ratios of the MSCI Emerging Markets Index and those of the broad developed markets near the end of Historically, emerging-market stocks have tended to possess lower relative market valuations in recognition of their higher perceived investment risk. Implications for asset-allocation strategies To examine the potential portfolio construction implications of Vanguard s range of expected long-run returns, Figure 5, on page 7, presents simulated real (inflation-adjusted) return distributions for for three hypothetical portfolios ranging from more conservative to more aggressive: 20% equities/80% bonds. 60% equities/40% bonds. 80% equities/20% bonds. For reference, the figure also shows how the hypothetical portfolios would have performed over two past periods: and Figure 5 has several key implications for strategic asset allocation, as discussed next. 5 See Investing in Emerging Markets: Evaluating the Allure of Rapid Economic Growth (Davis et al., 20). 6 For further details, see Asset Allocation in a Low-Yield and Volatile Environment (Davis, Aliaga-Díaz, and Patterson, 2011). 5

6 Figure 4. Market valuations are similar across the major equity benchmarks 50 Ratio of price to 12-month trailing earnings MSCI Developed Markets Index (ex US) MSCI US Equity Index MSCI Emerging Markets Index Note: Data from December 31, 1994, through November 30, Source: Thomson Reuters Datastream. Modest outlook for long-run real returns Given widespread concern over the current low level of dividend yields and long-term U.S. Treasury yields, Figure 5 s real long-run return profile for balanced portfolios may seem better than expected. However, Vanguard believes it s important for investors to consider real-return expectations when constructing portfolios because today s low dividend and Treasury yields are, in part, associated with lower expected inflation than those of 20 or 30 years ago. Figure 5 does show that the inflation-adjusted returns on a balanced portfolio over the decade ending 2022 are likely to be moderately below long-run historical averages (indicated by the small red boxes for ). However, the likelihood of achieving real returns in excess of those since 2000 for all but the most conservative portfolios is considerably higher. Principles of portfolio construction are intact Contrary to suggestions that the next decade warrants some radically new investment strategy, Figure 5 reveals that the simulated ranges of expected returns are upward sloping. Simply put, higher risk accompanies higher (expected) return; more aggressive allocations have a higher and wider range of expected returns, with greater downside risk in the event that the equity risk premium is not realized over the next decade. Indeed, these expected risk return trade-offs among stocks and bonds show why Vanguard s principles of portfolio construction remain unchanged, in our view, even if expected returns are lower. Implications of searching for yield In fact, the upward-sloping and wider-tail pattern in Figure 5 reaffirms the beneficial role that bonds should be expected to play in a broadly diversified portfolio, despite their currently low yields and regardless of the future direction of interest rates. Although our scenarios generate slim, below-average nominal returns for a broad taxable bond index for the next ten years a central tendency of 1% 2% annually, on average bonds should be expected to moderate the volatility in equity portfolios in the years ahead. For additional thoughts on America s economic future, please see the accompanying interview with Mr. Davis, on pages

7 Figure 5. Real return outlook for various stock/bond portfolios over the next ten years Real returns, ten-year horizon Annualized geometric return 18% Key U.S. history, U.S. history, th percentile 25th 75th percentile %/80% 60%/40% 80%/20% Portfolio stock/bond allocation 5th percentile Underlying data for this figure Portfolio stock/bond allocation 20%/80% 60%/40% 80%/20% Bottom 5th percentile 3.2% 3.2% 3.8% 25th percentile 0.6% 1.1% 1.7% Median 1.1% 4.1% 5.6% 75th percentile 2.8% 7.2% 9.4% Top 95th percentile 5.2% 11.6% 14.8% Annualized portfolio volatility 6.6% 11.5% 14.6% U.S. history, % 5.5% 6.2% U.S. history, % 1.8% 0.9% Notes: Percentile distributions were determined based on results from the Vanguard Capital Markets Model (described on pages 3 and 36). For each portfolio allocation,,000 simulation paths for U.S. equities and bonds were combined, and the 5th, 25th, 75th, and 95th percentiles of return results are shown in the box and whisker diagrams. The small red and yellow boxes indicating U.S. historical returns for and represent equity and bond market annualized returns over these periods less the inflation rate, as defined by the U.S. Consumer Price Index. The equity returns represent a blend of 70% U.S. equities and 30% international equities; bond returns represent U.S. bonds only. Returns are based on the broad-market indexes listed in the box on page 3. Sources: Vanguard calculations, including VCMM simulations (see pages 3 and 36); Barclays; and Thomson Reuters Datastream. For further details, see Davis, Aliaga-Díaz, and Patterson (2011). References Davis, Joseph H., Dividend-Paying Stocks Are Not Bonds. Vanguard blog posting, November 11; available at Davis, Joseph H., and Roger Aliaga-Díaz, Vanguard s Economic and Investment Outlook. Valley Forge, Pa.: The Vanguard Group. Davis, Joseph H., Roger Aliaga-Díaz, and Andrew J. Patterson, Asset Allocation in a Low-Yield and Volatile Environment. Valley Forge, Pa.: The Vanguard Group. Davis, Joseph, Roger Aliaga-Díaz, and Andrew J. Patterson, Vanguard s Economic and Investment Outlook. Valley Forge, Pa.: The Vanguard Group. Davis, Joseph H., Roger Aliaga-Díaz, and Charles J. Thomas, Forecasting Stock Returns: What Signals Matter, and What Do They Say Now? Valley Forge, Pa.: The Vanguard Group. Davis, Joseph H., Daniel W. Wallick, and Roger Aliaga-Díaz, 20. Vanguard s Economic and Capital Markets Outlook. Valley Forge, Pa.: The Vanguard Group. Davis, Joseph H., Roger Aliaga-Díaz, C. William Cole, and Julieann Shanahan, 20. Investing in Emerging Markets: Evaluating the Allure of Rapid Economic Growth. Valley Forge, Pa.: The Vanguard Group. Davis, Joseph H., Roger Aliaga-Díaz, Julieann Shanahan, and Charles Thomas, Which Path Will the U.S. Economy Follow? Lessons From the 1990s Financial Crises of Japan and Sweden. Valley Forge, Pa.: The Vanguard Group. Davis, Joseph H., Roger Aliaga-Díaz, Charles J. Thomas, and Nathan Zahm, The Long and Short of TIPS. Valley Forge, Pa.: The Vanguard Group. 7

8 America s economic future: Are better days in store? In the wake of the financial crisis and a stubbornly sluggish U.S. recovery, some economists have questioned the ability of the nation s new technologies to deliver the kind of productivity boosts that have accelerated growth and enhanced living standards over the past two centuries. In a recent interview with Vanguard Investment Perspectives, Joseph Davis, head of Vanguard s Investment Strategy Group, explained why he s optimistic about the impact of current technological advances on America s long-term economic future. Can the United States ever get back to more robust economic growth? Revolution and ended soon after the Civil War. The second began shortly afterward with Edison s incandescent lightbulb and ended about two decades after World War II. Our third industrial revolution began in the 1970s, and it s far from over. Mr. Davis: Business investment has always been our accelerant for economic growth, but investment as a share of our economy is near an all-time low, the lowest since the 1930s, and actually lower than the 1970s. Our economy actually has an investment deficit. That is why growth is weak. The current environment is the historical exception, not the rule, and it s not sustainable. Why is weak growth not sustainable? Mr. Davis: In the near term, for no other reason than good old wear and tear. Machines, buildings, and infrastructure need repair and replacing. Over the longerterm, investment will rebound because as technologies are adapted, adopted, and improved, they ll make companies smarter, faster, and better. In fact, I believe we are in the middle of a third industrial revolution. The first was sparked by the development of the steam engine around the time of the American What s driving this newest industrial revolution? Mr. Davis: The spark came in the 1970s with the microprocessor, and its pattern thus far has been strikingly similar to that of the first two. In the first two industrial revolutions, overconfidence eventually emerged in the U.S. economy reflecting an incredible amount of capacity, and perhaps too much debt. Bubbles developed in the stock market, in real estate, and in housing. Then the bottom fell out, resulting in a decade of recession, or even depression. To survive brutal economic times, businesses do whatever it takes. They cut costs, and that can mean adopting new technologies to expand opportunities to preserve profits. It s a very painful and disruptive process, but over time, something very important happens. The prices for those original new technologies don t just drop, they drop precipitously. During the first industrial revolution, the relative cost of steam power technology fell nearly 90% in 30 years. The relative cost of electricity in the second industrial revolution fell 95%. Author Jim Collins has a fantastic phrase for this sort of momentum: the flywheel effect. 8

9 In our recent history, as computing technologies have become widely available, they ve been adopted across many industries and become part of our daily lives, resulting in a tremendous boom in investment in the 1990s and 2000s. There was a belief, briefly, in a new economy, a world where we would no longer have business cycles and recessions. Then it all collapsed, and we re still working through the effects of that collapse today. Today, with investment low and growth weak, there are some who believe that we are stuck here permanently for decades. But through this recent boom and bust, something very important happened. Computer hardware, software, and the internet have combined, merged, and morphed into a global digital network. For the first time in history, billions of human beings can interact and exchange information virtually instantaneously. The flywheel effect has been very busy. The cost of computer processing power the sending and storing of information has plummeted to the point that it is virtually free. Computer technology now permeates our society, just as steam power and electricity eventually did. Figure 1. Economic progress is not a straight line So what happens from here? We are here Note: This line represents the pattern of growth during an industrial revolution that is, slow, then rapid progress, followed by a bust and renewed growth. Source: Vanguard. Mr. Davis: I like to use a simple line graph to show where we are in the cycle. The line [see Figure 1] equals growth and investment. The line is not straight, because economic progress never is. In the previous two industrial revolutions, we saw this play out with a boom, a bust, and then resumption of growth. And I believe we are ready to witness the second wave of growth in our third revolution. As computer technology continues to spread, there will be further enhancements, innovation, and investment. What s in store in this second wave? Mr. Davis: We ll continue to see digital and computer technologies advancing and evolving, finding new business opportunities in a whole array of industries. For example, nanotechnology has enabled tiny particles to enhance and improve thousands of consumer products everything from sunscreen to lightweight packaging and glass. In the field of trade, for the first time in U.S. history we can export one of our greatest competitive advantages the service sector. High-value-added services, such as logistics, legal services, medical services, engineering, and architectural design have become more cost-effective through digital and video technology. In energy, just over the past four or five years we ve seen an explosion in high-miles-per-gallon vehicles. There are exciting developments in battery energy storage, and in energy exploration, which opens the door to U.S. energy independence. There are remarkable advances in manufacturing, such as three-dimensional printing, which allows the use of lasers and computers to convert digital information into tangible objects. Scientists call this additive manufacturing because it builds up objects layer by layer. The cost of this technology is falling dramatically, so much so that some scientists and engineers have desktop versions of these 3-D printers. Should this technology expand, it may one day change the calculus of where manufacturing and factories are located around the world. And we re seeing exciting advances in health care as technology allows us to analyze and synthesize vast amounts of data. The costs of many of these technologies are dropping markedly. For example, decades ago mapping the human genome would have cost hundreds of thousands, if not millions, of dollars. Today, the cost, per person, of mapping the human genome through digital technology is approaching $1,000 about the cost of an MRI. So I m excited about the opportunities ahead. I see a bright future for the United States. For more thoughts from Mr. Davis on this topic, see Better days are in store: Joe Davis on America s economic future, at vanguard.com. 9

10 About the Vanguard Capital Markets Model The Vanguard Capital Markets Model (VCMM) is a proprietary financial simulation tool developed and maintained by Vanguard s Investment Strategy Group. The VCMM uses a statistical analysis of historical data for interest rates, inflation, and other risk factors for global equities, fixed income, and commodity markets to generate forward-looking distributions of expected long-term returns. The VCMM is grounded in the empirical view that the returns of various asset classes reflect the compensation investors receive for bearing different types of systematic risk (or beta). Using a long span of historical monthly data, the VCMM estimates a dynamic statistical relationship among global risk factors and asset returns. Based on these calculations, the model uses regression-based Monte Carlo simulation methods to project relationships in the future. By explicitly accounting for important initial market conditions when generating its return distributions, the VCMM framework departs fundamentally from more basic Monte Carlo simulation techniques found in certain financial software. The primary value of the VCMM is in its application to analyzing potential client portfolios. VCMM asset-class forecasts comprising distributions of expected returns, volatilities, and correlations are key to the evaluation of potential downside risks, various risk-and-return trade-offs, and diversification benefits of various asset classes. Although central tendencies are generated in any return distribution, Vanguard stresses that focusing on the full range of potential outcomes for the assets considered, such as the data presented in these articles, is the most effective way to use VCMM output. The VCMM seeks to represent the uncertainty of the forecast by generating a wide range of potential outcomes. It is important to recognize that the VCMM does not impose normality on the return distributions but, rather, is influenced by the so-called fat tails and skewness in the empirical distribution of modeled asset-class returns. Within the range of outcomes, individual experiences can be quite different, underscoring the varied nature of potential future paths.

11 P.O. Box 2900 Valley Forge, PA Connect with Vanguard > vanguard.com Notes about risk and performance data: All investments, including a portfolio s current and future holdings, are subject to risk, including the possible loss of the money you invest. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index. There may be other material differences between products that must be considered prior to investing. Diversification does not ensure a profit or protect against a loss. 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. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. Investments in stocks or bonds issued by non-u.s. companies are subject to risks including country/regional risk, which is the chance that political upheaval, financial troubles, or natural disasters will adversely affect the value of securities issued by companies in foreign countries or regions; and currency risk, which is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates. 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. Vanguard research > Vanguard Center for Retirement Research Vanguard Investment Strategy Group > research@vanguard.com For more information about Vanguard funds, visit institutional.vanguard.com, or call , to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing. High-yield bonds generally have medium- and lowerrange credit-quality ratings and are therefore subject to a higher level of credit risk than bonds with higher credit-quality ratings. While U.S. Treasury or governmentagency securities provide substantial protection against credit risk, they do not protect investors against price changes due to changing interest rates. U.S. government backing of Treasury or agency securities applies only to the underlying securities and does not prevent share-price fluctuations. Investments that concentrate on a relatively narrow market sector face the risk of higher share-price volatility. In a diversified portfolio, gains from some investments may help offset losses from others The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.