Vanguard management is not lying. But… it measures performance in what I consider to be a very misleading way. They average annualized returns from the start of every year.

Vanguard’s official annual performance numbers can be deceptive. The fund return figures that are so frequently cited (1-year, 3-year, 5-year periods) are an unreliable (and dangerous!) method for choosing which Vanguard funds to trust with your hard-earned money.

Why Is This a Poor Way to Analyze Performance?

This method assumes that an investor has put his or her money into the fund at the beginning of the calendar year and kept it there for the next 12 months.

But do average investors do that? Of course not.

The result is that the performance figures that both Vanguard itself and the financial media all cite can be hazardous to your financial health. The truth that Vanguard doesn’t want you to know is that actual returns are often much lower.

A More Scientific Method for Measuring Fund Performance

Rolling returns is a much more scientific method for measuring mutual fund performance.

Instead of focusing in on one 12-month period, rolling returns measure more than 80 3-year and more than 50 5-year time periods — January 2004 to January 2005, February 2004 to February 2005 and so on.

Each of these periods is a “snapshot” of a fund’s actual real-world performance. With dozens of these snapshots averaged together, you can arrive at a more accurate measure of how a fund is performing.

Take a look at the table below.

What you should notice is that the annualized 3-year returns look pretty darned spectacular. And the 5-year numbers look pretty punk.

The net result is that if you were to rank the Vanguard funds by their 3-year returns, the ranking would look quite a bit different from the ranking based on 5-year returns.

For example, Value Index shows a 3-year average annual return of 16.3%… but its ROLLING RETURN is just 5.8% — 64% less.

Windsor II shows a standard 3-year return of 15.7%. An inexperienced investor might be inclined to dump a big wad of cash into this fund. But my more scientific rolling return analysis shows this fund posted a very modest 6.8% over a 3-year time period — or less than one-half as good.

So keep your skeptic’s hat on when these 3-year and 5-year “ranking” articles appear in a newspaper or magazine.

A Vanguard Mutual Fund That Measures Up

One Vanguard fund that has superb rolling returns is Strategic Equity.

As the markets swing from growth to value, or vice versa, this fund goes with the flow and will continue to outperform most of the small- and mid-cap funds with low expenses and optimized trading strategies.

Run by Vanguard’s chief investment officer using the computers also used to run their hundreds of billions in indexed assets, Strategic Equity should be a central part of any Vanguard investor’s portfolio.

Vanguard itself uses this rolling returns method when assessing the performance of its own fund managers. It doesn’t share those numbers with its investors, but keeps the results secret. Shouldn’t you know the rolling return record of the funds you own — or are thinking of buying?

Dan Wiener provides subscribers to his The Independent Adviser for Vanguard Investors with the rolling returns data for ALL Vanguard funds. To gain this competitive advantage for your portfolio, consider a risk-free trial to The Independent Adviser today. For details on how to join risk-free for six months, click here.