Vanguard target retirement funds

Last major update: 04/20/08

Introduction
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 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. TR Income has a static allocation, intended primarily for the needs of retired persons.

Fund Allocations
As of April 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 and pie charts.

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

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.

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 0.19% to 0.21%. 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.

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: Target Retirement Funds change investments, but not approach to investing. 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.

Links

 * Forum Reference Library: Target Retirement Funds (academic and practitioner papers)
 * Glide path for Target Retirement funds (Forum topic)
 * Bond allocation - are Target Retirement Funds too aggressive (Forum topic)