My company made Vanguard Target Retirement Funds available for our 401k accounts about two years ago. However, I have not used them since I prefer to manually manage my portfolio using traditional funds that include bond, large-cap, small-cap, international stock, and REIT funds. However, Target Retirement Funds are not without merits. In fact, I’ve been using Target Retirement Funds for my SEP IRA.
A target retirement fund is a mutual fund designed with a specific retirement year in mind (usually in 5 year increments). For example, if you are 35 years old now and you’d like to retire when you turn 65, you can invest in a 2040 Target Retirement Fund. As the fund approaches the target retirement year, the fund allocation becomes more conservative — investing in more fixed-income investments — to decrease risk and preserve capital.
Here’s Vanguard 2010 versus 2040 to give you and idea on how the fund changes over time:
Roughly speaking, Vanguard 2010 is more conservative with a 45% allocation to bonds versus only 10% bonds for Vanguard 2040. As time progress, Vanguard 2040 will slowly increase its bonds position.
Personally, I think there are two things that make Target Retirement Funds attractive.
Diversification — Target retirement funds help you automatically diversify between the two most important asset classes — equity and fixed-income. Additionally, Target Retirement Funds are what The Street calls “Funds of Funds“. This means they invest in other mutual funds, making them a very diversified investment. For example, Vanguard 2040 is comprised of the following funds:
|Vanguard Total Stk Market Idx Fd Inc||72.08%||0.15%|
|Vanguard Total Bond Market Index||10.11%||0.19%|
|Vanguard European Stock Index||9.74%||0.22%|
|Vanguard Pacific Stock Index||4.37%||0.22%|
|Vanguard Emerging Mkts Stock Idx||3.66%||0.37%|
There are also a few things that make Target Retirement Funds unattractive:
There are also a few other things you may want to consider when investing in Target Retirement Funds.
As mentioned before, owning other investments in addition to a Target Retirement Fund can actually work against you due to skewing. This means that if you want to get into a Target Retirement Fund you may have to consider liquidating your existing portfolio. At the very least, be very careful with its asset allocation. Portfolio liquidation can be a problem for investors who have accumulated a large amount of assets. Trading costs and potential tax consequences (especially for investments in taxable accounts) can erode returns and cause financial strain.
Some Target Retirement Funds are actively managed, and there’s the potential that your fund manager may stray from the stated investment policy. For example, he or she may be investing more aggressively than stated in order to outperform other Target Retirement Funds. This is especially worrisome for investors who are near their retirements.
Note: this is not the case with Vanguard Target Retirement Funds, which are made up of index funds.
Personally, I remain undecided about whether or not I should leverage a Target Retirement Fund. I enjoy managing my own portfolio, and there are some disadvantages to consider. However, I think investing in a Target Retirement Fund in my non-401k accounts might be a good option; it will at least make life simpler. Also, I think Target Retirement Funds are good for people who don’t want to bother managing the portfolio on their own. A target date fund is far better than neglecting the portfolio altogether.
What are your thoughts on Target Retirement Funds? Do you invest in them? What do you like or dislike about them?