Vanguard Fund to Avoid #3: Diversified Equity (VDEQX)

This is one of Vanguard's newer funds. Bowing to those who say active management can beat the indexes, Vanguard chose to prove this theory wrong. The result is Diversified Equity.

The problem with this fund? Instead of investing entirely in index funds, like many of the others, this one invests in a portfolio of eight actively managed Vanguard funds. That adds up to some 20 different management teams. Not only is this fund way overdiversified, it's also handled by a team of Vanguard's worst managers!

Based on my back-testing of performance of its underlying funds, Diversified Equity should perform almost like a clone of Total Stock Market. I had hoped that with time and some improvements to the management teams, the fund would begin to show some outperformance. But it's still trailing Total Stock Market (while taking on more risk), and I don't see that changing anytime soon.

Whichever way you cut it, my model portfolios have put this fund to shame. Stay away from this one.

The One Vanguard Fund to Buy Now: Strategic Equity (VSEQX)

This is one of my top buys right now for one simple reason: It's a fund with a history of protecting shareholders. Its approach to selecting both growth and value stocks meant it didn't dive as deep in the 2002 bear market.

This Vanguard fund uses computer models to select stocks for its portfolio using a special index benchmark to avoid straying too far from the "norm." As the markets swing from growth to value, or vice versa, this fund goes with the flow. It will continue to outperform most of the small- and mid-cap funds with low expenses and optimized trading strategies.

And here's one of its biggest secrets (although subscribers to my Independent Adviser service have known this for quite a while.) After a false start, fund performance has skyrocketed. The fund had just over $900 million in assets at the end of 2002. It now has $8 billion!

Despite the rapid increase in size, I'm still convinced it's going to win the performance derby.

Vanguard closed this fund in the spring of 2006 and then reopened it in November 2006 with a higher minimum investment. However, there are signals that Vanguard may be closing it again in a few months—so get in now, before it's too late.

For over 17 years, independent Vanguard "watchdog" Dan Wiener has been telling subscribers to his Independent Adviser which underperforming, poorly run, undiversified or tax-inefficient funds to avoid AND giving them the best Vanguard investments for their money. In fact, the recommendations in his Growth Portfolio earn a 144% advantage over the typical Vanguard investor! Don't miss the chance to gain this competitive advantage for your portfolio. Click here to accept a risk-free trial to The Independent Adviser for Vanguard Investors today.