Vanguard Target Retirement Funds

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Bogleheads Investing Start-Up Kit: Implementing an Investment Plan

For Introduction to Investing and Asset Classes see Bogleheads Investing Start-Up Kit.

The Vanguard Target Retirement (TR) Funds are lifecycle offerings, providing investors with a variety of highly diversified all-in-one portfolios. The products are structured as funds-of-funds, charging only weighted averages of the expense ratios associated with the underlying holdings, which are primarily indexed. While the Funds are ostensibly designed for investors retiring in a given year (approximately), they may be used for other goals or for markedly different retirement dates, depending on a particular shareholder's objectives and risk tolerance.

Each of the Funds, except the Vanguard Target Retirement Income Fund (TR "Income"), has a date specified in its name. They become more conservative over time, shifting their asset allocations from equities toward fixed income. The Funds' prospectus indicates that within seven years of the stated date, a given offering's asset allocation will come to resemble TR Income's. Vanguard's TR Income Fund has a static allocation, intended primarily for the needs of retired persons.

Vanguard LifeStrategy Funds are similar to TR Funds. Both LifeStrategy funds and Target Retirement funds can be used as an all-in-one portfolio. For more information on comparing LifeStrategy funds with Target Retirement funds, see LifeStrategy Funds vs Target Retirement Funds. For academic research on Target Retirement funds, please refer to Target Retirement Funds.

Contents

Choosing a Target Retirement Fund

Target retirement funds are marketed for investors who want simplicity of managing their investments. These funds make assumptions about their potential investors; one of which is asset allocation, the single most important decision an investor has to make. They can not know the amount of risk willing to be undertaken by the individual investor.

When choosing a fund, the Bogleheads recommendation is to ignore the fund's date. Instead, determine the amount of risk the investor is willing to tolerate and work backwards to find a fund that matches the chosen stock/bond allocation. The investor may be surprised to find a large discrepancy between the planned retirement date and the fund's target date. Remember that the fund does not know the individual investor.

There are some disadvantages to this method (see below), but the beginning investor should not be dissuaded. Rebalancing at a later time is always an option, especially if this is a tax-advantaged account.

Vanguard's Investor Questionnaire is designed to assist investors with choosing an asset allocation. (Select: "Begin the Vanguard Investor Questionnaire")

Advantages

Diversification

With the purchase of a single fund, investors gain exposure to a broad portfolio of US and international stocks, and thousands of bonds. These funds are excellent choices for investors who don't have the required initial minimum investments for purchasing separate funds.

Asset Allocation on Autopilot

Asset allocation is managed professionally by Vanguard. It will change automatically as investors get closer to retirement.

Criticisms

While TR Funds provide very simple diversification for their shareholders, such uniform solutions will necessarily be subject to reasonable criticisms.

Mismatch Between Target Retirement Year and Asset Allocation Choice

The funds set an asset allocation for a given target retirement year. Not all investors want the same allocation even if they will retire in the same year. Some may find the TR fund's allocation for their target year too aggressive or too conservative. If these investors select a TR fund by its current asset allocation, and not the target year, they may find that the fund shifts its asset allocation either too soon or too late.

For example, suppose you plan to retire in 2030, but you think the 85% stocks 15% allocation in Vanguard Target Retirement 2030 Fund is too aggressive for your need, ability and willingness to take risk. Instead, you like the allocation in Vanguard Target Retirement 2015 Fund, which currently invests approximately 65% in stocks and 35% in bonds. If you invest in Target Retirement 2015, however, at some time close to 2015, the fund will shift its allocation more conservatively, while you are still at least 15 years away from your planned retirement. On the opposite, if you'd like to be more aggressive and invest in Target Retirement 2035 while you plan to retire in 2015, you may find the allocation in Target Retirement 2035 not shifting when you need a less aggressive allocation after you retire.

Tax Inefficiency

Because the TR Funds all have an increasing and/or large allocation to taxable bonds, they are most suitable for investors holding their entire portfolios in tax-advantaged accounts. They also might be appropriate for individuals with entirely taxable portfolios, if there is high likelihood of a low tax bracket for the intended holding period, which is usually a lifetime. Investors having both taxable and tax-advantaged accounts are generally better served by splitting their equity and fixed income allocations, concentrating on tax-efficient asset location.

TR Funds historical distributions:

Allocation Choices

Depending on an investor's personal preferences, the TR Funds' asset allocations could be unsatisfactory. Some example reasons follow.

  • Certain asset classes are not represented. Foreign bonds, foreign small cap stocks, Canadian stocks, and commodities are entirely absent. Inflation-protected securities currently appear in only the TR Income, 2005, and 2010 options.
  • The Funds' asset class weightings do not suit all tastes. 80% of equities are domestic, far above the U.S. share by world market capitalization. There is no "tilt" to the U.S. stock holdings; for instance, REITs are represented only to the extent they appear in Total Stock Market Index.

Expenses

TR funds are cheap by any reasonable standard, with Vanguard Target Retirement Fund expense ratios varying from 0.18% to 0.19%. In fiscal year 2008, the average peer group expense ratios ranged from 1.11% to 1.32%. Other mutual fund companies' Target Retirement Fund expense ratios may include an additional expense ratio on the Target Retirement Fund itself, in addition to the expense ratios of the underlying funds. Vanguard does not charge this type of fee, but investors using Target Retirement Funds in their workplace plan from another mutual fund company should look in the prospectus for this possible extra expense.

Despite the already low expense ratios, Vanguard could create even cheaper versions. The underlying holdings are presently all Investor Class, but with the exception of Prime Money Market, all the funds utilized already have Admiral and Institutional share classes. Admiral Class TR Funds would serve individual shareholders with substantial balances, whereas Institutional Class TR Funds would serve workplace retirement plans. On the other hand, Vanguard incurs substantial costs in creating and maintaining the TR vehicles. These costs are not passed on directly to their shareholders, and the absence of additional share classes could be viewed as a sort of reimbursement.

Summary Asset Allocation

As of October 2008, TR Fund asset allocations range from 90/10 (stock/bonds) to 31/69 (stocks/bonds+cash).

TR Fund Asset Allocations - October 2008
Holding 2050 2045 2040 2035 2030 2025 2020 2015 2010 2005 Income
Stocks 90.2 90.2 90.3 90.3 85.3 78.0 70.6 62.8 53.7 31.0 30.6
Bonds + Cash 9.8 9.8 9.7 9.7 14.7 22.0 29.4 37.2 46.3 69.0 69.4


Detailed Fund Allocations

As of October 2008, the TR Funds' equity allocations varied from 30% (TR Income) to 90% (TR 2035-2050). More detailed allocation information is provided in the following table. The three year standard deviations of monthly returns, a measure of volatility risk, are also provided for funds having three years or more of investment returns. Continuous updates of these figures are available at Vanguard Institutional

TR Fund Underlying Percentage Holdings - October 2008
Holding 2050 2045 2040 2035 2030 2025 2020 2015 2010 2005 Income
Vanguard Total Stock Market Index Fund 72.2 72.1 72.0 72.1 68.2 62.2 56.3 50.2 42.9 32.8 24.3
Vanguard European Stock Index Fund 9.8 9.9 10.0 9.9 9.4 8.5 7.8 6.9 5.9 4.6 3.5
Vanguard Pacific Stock Index Fund 4.5 4.5 4.4 4.6 4.1 4.0 3.4 3.1 2.7 1.9 1.5
Vanguard Emerging Markets Stock Index Fund 3.7 3.7 3.9 3.7 3.6 3.3 3.1 2.6 2.2 1.7 1.3
Vanguard Total Bond Market Index Fund 9.8 9.8 9.7 9.7 14.7 22.0 29.4 37.2 40.0 42.2 44.6
Vanguard Inflation-Protected Securities Fund 6.3 14.2 19.4
Vanguard Prime Money Market Fund 2.6 5.4
3-Year Standard Deviation (12/31/2008)[1] 14.78 14.73 12.88 10.61 7.95 6.52


History

Vanguard's launched its first six TR Funds on 10/27/2003: TR 2045, 2035, 2025, 2015, 2005, and Income. The remaining funds have an inception date of 06/07/2006: TR 2050, 2040, 2030, 2020, and 2010.

In March 2006 Vanguard made changes to the asset allocations of its existing TR Funds, increasing their aggressiveness. The original TR Fund allocations are provided in the Funds' preliminary prospectus, dated 08/05/2003. Note the five year differential in making comparisons with current breakdowns.

Original TR Fund Underlying Percentage Holdings - October 2003
Holding 2045 2035 2025 2015 2005 Income
Vanguard Total Stock Market Index Fund 72 64 48 40 35 20
Vanguard European Stock Index Fund 13 11 08 07
Vanguard Pacific Stock Index Fund 05 05 04 03
Vanguard Total Bond Market Index Fund 10 20 40 50 50 50
Vanguard Inflation-Protected Securities Fund 15 25
Vanguard Prime Money Market Fund 05


The funds' fiscal year ends on 9/30 of each year.

See also

Links

Notes

  1. ↑ Statistical data on the funds can be found at Vanguard Statistical Data Spreadsheets


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