Vanguard STAR Fund vs. Vanguard Balanced Index Fund

I previously wrote about how the Vanguard Balanced Index Fund was a good example of the benefits of holding both stocks and bonds in your portfolio. Now, I’d like to extend this and compare the Vanguard Balanced Index Fund (VBINX) with another veteran balanced fund, the Vanguard STAR Fund (VGSTX). They are similar yet different:

Here’s a chart of how $10,000 invested 10 years ago would have done. With the Vanguard STAR fund, you’d have $20,653 today. With the Vanguard Balanced Index fund, you’d have $19,749. (This is with Investor shares, which have a lower minimum investment than Admiral shares. The minimum used to a lot higher, but now it is $10,000 for Admiral shares.)

(click to enlarge)

My observations:

Asset allocation matters. Both funds are 60% stocks/40% bonds. But the STAR fund invests in 11 different underlying mutual funds, each with their own analysts carefully buying and selling securities as they see opportunities. These are some of Vanguard’s best managers, picked and pruned over time. Meanwhile, the Balanced fund just blindly follows an index, day in and day out. Yet the charts for both look very similar.

Active can beat passive over relatively long periods. Over the last 10 years, STAR has beaten Balanced by 0.36% (0.24% with Admiral shares, with a higher balance requirement). Even if you note that international stocks in general have outperformed domestic stocks over the last 10 years, Total International only beat Total US by 0.36% annually (8.31% vs 7.95%). Given that this would only have replaced about 30% of the fund (half of 60% stock holding), it would still roughly appear that the STAR fund may very well have created “alpha” over a long period. This is rare, but it still happens. I don’t know the exact risk-adjusted returns.

Costs still matter. STAR fund’s little bit of alpha is only possible due to the low 0.34% expense ratio. If the expense ratio was closer to the industry average for actively-managed funds, say 1% or another 0.66% more expensive, then that outperformance would have turned into underperformance. 7.22% minus 0.66% = 6.56%. I don’t know of any actively-managed funds that are cheaper than those at Vanguard.

Passive does really well without breaking a sweat. STAR might be able to do better in the future. It might not. If you like the idea of taking a chance of getting higher returns (meaning a chance of lower returns), then I don’t think holding STAR would be a bad choice due to its low costs and solid stewardship. However, I remain impressed by the seemingly effortless power of passive investing over the long run, despite all the smart people spending their lives trying to pick winners and ignore losers. Less stress for me is better. My portfolio remains predominantly passive and low-cost.