Vanguard CEO: Index Investors, Don't Get Spooked

Firm's new chief executive champions—what else?—diversification.

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Dozens of fund managers got frantic calls from shareholders yesterday, asking everything from whether their fund held any Lehman, AIG, or Bank of America to what the manager planned to do about it. But you wouldn't expect calls to flood into a fund family built on indexing—that is, hands-off investing in an index that is transparent to anyone who cares to look up the holdings. But Vanguard received an uptick in phone and Web traffic yesterday, says the firm's brand-new CEO, Bill McNabb, who was in D.C. for a conference. Here are a few insights he offered, as well as advice for jittery shareholders:

On why the market drop doesn't "have to be devastating":

Investors are asking the natural questions: How does this affect me? Do I need to worry about it? The good news is with highly diversified portfolios, these events—while traumatic—don't have to be devastating. It'll be some time before people see the full impact of how this plays out ... it's going to take some time. Our role is to be straightforward and to make sure that we're giving very clear answers and to take a little noise out of the marketplace. On putting market history into perspective...

They call it the "Lost Decade" for stocks. Stock returns are poor, real returns are probably down—if you look through August—1 percent or 1.5percent. It's not a great thing, right? You tell people long term, but they say, "Gee, I thought 10 years was long term. How do I think about that?" We try to do two things:No. 1, try to put a little perspective around it. If you look at the last 70-plus years of history—close to 80 years—and you look at rolling 10-year periods on a monthly basis, 12 or so percent of those periods have negative real returns. That's obviously not a majority, but it's certainly not uncommon. So what we've been going through in the equity markets in the last decade is not uncommon. ...And stretching the definition of "long term":

Point No. 2 is that markets tend to revert to their long-term averages. But how you think about long term, I think, has to be stretched further. And that really leads you to, I think, by far the most important thing: the power of diversification. I'm looking at 10-year numbers for stocks—[which have returned] roughly 4.5 percent .... It seems like motherhood and apple pie to talk about diversification and balance, but it just keeps coming back, over and over. Think about every period for last 25 years that we've gone through and how much better the diversified investor is than somebody who had all of his or her eggs in one asset class .... It doesn't insulate you totally—when you have a period when stocks and bonds both do poorly, then you're not going to look great—but in the long run, that balance has been really important.