The Vanguard Target Retirement Funds are like an automated amusement park ride for investors.
Hand over your money and you’ll start by gliding up the rails of accumulation hill with a thrilling 80/20 equity/bond portfolio.
You’ll probably do some loop-the-loops during those early years – and maybe even a double-inversion stall – as the market tests your stomach.
But as the ride progresses, your investment vehicle slackens off the pace. And by the time you’re ready to retire, it’s shifted you to a much gentler 50/50 equity/bond track.
As you coast down the final decumulation straight, your Target Fund should be about as scary as a kids’ log flume, bobbing along with a 30/70 equity/bond portfolio for a motor.
Scream if you’ve had enough of this metaphor.
Vanguard’s target retirement fund in a nutshell
The point is you can be hands-off throughout the journey – except to put cash in or whip it out again, depending on your time of life.
Vanguards’ Target Retirement Funds are examples of target-date funds, which are designed to help you hit a particular goal (like retirement). Their big benefit is to mostly relieve you of tricky investment decisions such as:
Asset allocation – You get an oven-ready, globally-diversified portfolio of equities and bonds that takes care of itself.
Rebalancing – All done as part of the service. That’s a very good thing, as selling your winners and buying your losers is tough to do sometimes.
Risk management – You start with an aggressive equity load-out when you’re young and have plenty of time to recover from bear markets. You gradually shift to less volatile bonds to protect your gains later on:
This is a perfectly reasonable risk management technique called lifestyling – although we do think having 70% in bonds risks under-powering your retirement. More on that in a minute.
Underlying holdings – Vanguard Target Retirement Funds invest exclusively in Vanguard’s own passive investor-friendly range of index trackers. We’ve no objection. Other trackers are available but Vanguard has a solid range, and choosing your own is liable to bag you marginal gains, at best.
Cost – There’s a 0.24% Ongoing Charge Figure (OCF). That’s no longer cheap for a global tracker fund. But it’s good value for a multi-asset fund that does almost everything for you bar filling in the direct debit.
All you have to do is decide when you’re going to retire.
How the target date works
Each Vanguard Target Retirement Fund comes with a target date that identifies the earliest year its investors are expected to retire.
For example, the Vanguard Target Retirement Fund 2030 is aimed at investors who plan to flick the Vs to working life between 2030 and 2034, while the Vanguard Target Retirement Fund 2035 is just the ticket if you’re planning to hold your F.U. party between 2035 and 2039.
On we go in five-year steps out to the impossibly futuristic Vanguard Target Retirement Fund 2065 – by which time The Investor will be tapping out posts with cybernetic fingers and I’ll have been uploaded to the cloud.
You’re a forward-thinking 15-year old who’s already dreaming of life on a Martian golf course from 2070? No doubt Vanguard will soon be releasing a fund for you, too.
The declining glidepath smoothes the way
It’s the interaction of the target date and the fund’s asset allocation that controls your descent towards a happy retirement.
The Target Retirement Fund 2030 is 61% in equities at the time of writing, with six years to go until the target date of 2030.
The fund will be split fifty-fifty in 2030. By 2034 it’ll be 40% equities, then 30% equities in 2037 – seven years after reaching its target date.
Here’s how each fund comes into land:
The Year of retirement in the graph refers to each fund’s target-date year.
Vanguard has illustrated a notional retirement age of 68 but you’d still be 50/50 equities/bonds whether you actually choose to retire at age 48 or 78 in 2030 when using the Target Retirement Fund 2030.
At the start of the journey (left-hand side of the graph) you’ll hold:
- 20% UK equity (red)
- 60% Global equity ex-UK (teal)
- 5% UK nominal bonds (turquoise)
- 15% Global bonds (brown)
Five years before retirement, UK index-linked gilts (orange) also come into play. These should help protect the portfolio from inflation.
By the time the glidepath touches down at age 75 your final asset allocation is:
- 7.5% UK equity (red)
- 22.5% Global equity ex-UK (teal)
- 3.5% UK nominal bonds (turquoise)
- 17.5% UK index-linked gilts (orange)
- 49% Global ex-UK bonds (brown)
Again, all completely sane.
That said, the convenience you gain by ceding control comes at the cost of making compromises.
Target Retirement Funds are superb for those who don’t want to manage their own investments, but there are quite a few drawbacks to consider.
For instance…
A rising glidepath may be better for retirees
An alternative rising glidepath strategy peaks your bond holdings at your retirement age. Thereafter, it allows your equity allocation to rise again while spending down bonds.
The theory is that maxing out bonds on the eve of your retirement protects you from a hideously bad run of returns (known as sequence of returns risk) that could permanently damage your pension pot.
After that, holding a larger equity allocation should pay off if stock markets go on to deliver their typical gains.
If this theory holds then the traditional declining glidepath as followed by Target Retirement Funds is the very opposite of what you should be doing.
So does it hold?
The best research I’ve read on this topic comes from Early Retirement Now.
Big ERN concludes that a rising glidepath can help when the market is overvalued when you retire. The improvement is modest but quite consistent when using US long-term historical data.
So you may turn the retirement dial slightly more in your favour with a rising glidepath strategy. In practice it will depend on your individual circumstances and unknowable future investment returns.
70% bonds in retirement?
Most research into optimal retirement asset allocations finds against bond holdings as high as 70%.
Using historical global returns, we found that the higher your equity allocation, the more you could spend from your retirement portfolio.
That said, there’s reason to believe that historical simulations of retirement spending are somewhat biased against bonds because they oversample from the worst bond bear market in history.
Moreover, Vanguard’s target-date bond allocations include some corporate bonds. These come with more equity-like risks and rewards.
The Vanguard Target Retirement Fund 2015 holds 15% in corporate bonds1 for example. Its retirement asset allocation can be more properly thought of as 45/55 growth versus defensive assets, rather than a 30/70 split.
Even so, most retirement research suggests you need a much higher equity share than 30% in a decumulation portfolio.
One way of handling this would be to follow a Target Retirement Fund’s glidepath until you hit the 50/50 mark. Then sell and reinvest your proceeds into a static allocation fund such as Vanguard LifeStrategy.
That way you retain the auto-rebalancing, multi-asset convenience of a target-date fund but you could maintain a 60/40 portfolio for the rest of your days with the LifeStrategy 60 product.
Risk tolerance
There’s no guarantee that any particular Target Retirement Fund’s asset allocation matches your personal risk appetite.
Being young is not proof that you can hack an 80% equity allocation.
Theoretically, you’ve got years to recover if things go south. But that’s cold comfort if you freak out and sell during a bear market because you’re in way beyond your risk tolerance.
Of course, you could choose the Target Retirement Fund with the equity/bond mix that best suits your risk tolerance rather than your age. But do take care to check its asset allocation serves your needs as you countdown to retirement.
If you go for a 50/50 split then you may not want to be 30% in equities when the fund powers down seven years later but your retirement is still over a decade away, for example.
Try estimating your risk tolerance or take this test to get a feel for these issues.
Are bonds enough?
Talking of risks, many investors now find it harder to stomach the words ‘bonds’ and ‘safe assets’ breezily rubbing shoulders in the same sentence given the big bond crash of 2022.
Soaring inflation and central banks hiking interest rates as if their keyboard were stuck on the ‘+’ key caused yields to spike up on even the best government bonds that year.
Which simultaneously crashed bond prices.
As a direct result, that calamitous year saw balanced funds that held more bonds actually do worse then those that held more equities – despite share prices falling, too.
That was exactly the opposite of what people thought they were buying when they dialled up their bond allocation.
FT Money editor Claer Barrett in January even described lifestyling as ‘a hidden danger lurking in your pension pot’.
Recounting the case of ‘Martin’, Barrett wrote:
Forced into early retirement after developing a disability, Martin considered what to do with his biggest pension pot. Built up with a former employer, a statement from June 2021 said it was worth nearly £200,000. So he got quite a shock last October when he found its value had plunged to £134,000, wiping nearly one-third off of his pot. How could this have happened?
The answer, as I’m sure most of you have guessed, is lifestyling. As we move towards a more sedate pace of life in retirement, so too do our investments. Unless we say otherwise, money invested in most defined contribution pensions is gradually moved out of equities as we grow older and into bonds and cash, which have traditionally been lower risk investments. However, the dire performance of UK government bonds (gilts) in recent years means they have been anything but.
Tackling this criticism properly requires a full article – watch this space – but the first thing to say is fair enough.
Bonds did do extremely poorly in 2022. It was a generational-level shellacking. Little comfort if you were someone who saw your pension pot plummet just as you entered retirement that there were warning signs, or that equities crash like that far more often.
Especially if you’re a deliberately hands-off passive investor who chose a balanced fund to do the thinking for you. And specifically so you wouldn’t have to make timing calls.
The Monevator house view these days is that a really well-diversified portfolio needs more than bonds. But equally, we don’t think the outcome in 2022 has derailed the case for lifestyling a portfolio.
Mostly it should work well. Nothing will do so in all environments.
Bonds bounce back to life
Anyway, now is a bad time to abandon bonds. That very rare crash has actually boosted the prospects for their future returns.
Vanguard noted in late 2023 that:
The good news is that bond returns have recovered this year and the long-term outlook for bonds is better than it has been for many years.
We expect UK bonds to deliver annualised returns of around 4.4%-5.4% over the next decade, compared with the 0.8%-1.8% 10-year annualised returns we expected at the end of 2021, before the rate-hiking cycle began.
In retrospect, lifestyling was certainly more problematic in the near-zero interest rate era. But so were all our other investing decisions.
Again, would the typical target-date fund customer have done better making market timing calls instead?
I doubt it.
Auto-pilot malfunction
The final big danger with relying so heavily on Vanguard’s auto-pilot is that you forget to check if you’re still on course before the fund touches down.
Ultimately your fund will need to hit your target number by its target date.
All should be well if:
- Your fund meets or exceeds its expected returns…
- …and you put enough money in…
- …over a long enough period of time.
If performance is falling short then human intervention will be needed to increase your contributions, extend your timeline, or reduce your needs.
Tax efficiency
A Target Retirement Fund may not be tax efficient if it isn’t entirely sheltered by your ISAs, SIPPs, and personal savings allowance. That’s because bond interest payments are taxed at income tax rates rather than dividend income rates.
Moreover, once your target-date fund’s asset allocation is more than 60% bonds and cash then all of its distributions will be taxed as interest payments rather than dividends.
- See our post on how bond funds are taxed.
We still recommend Vanguard Target Retirement Funds
Despite these qualms, the overwhelmingly massive pro is that the Vanguard Target Retirement Funds are like a self-inflating survival shelter for people who can’t:
- Afford advice
- Learn the ropes
- Stay on top of their portfolio
- Make rational investing decisions
I’ve got lots of friends and family in this camp. And I would happily put every one of them in a Target Retirement Fund.
Any alternative path they’d choose for themselves is likely to be much worse.
Take it steady,
The Accumulator
P.S. Vanguard has occasionally made changes to the US version of the formula in response to market conditions. It increased the equities allocation and also broadened international exposure to equities and bonds. But the UK iterations – launched in December 2015 – have remained largely unchanged.
- Including securitised bonds. [↩]
