The Vanguard Target Retirement Funds are the state-of-the-art in investing convenience. They slice ‘n’ dice your money into a diversified portfolio, potentially juice your returns in the early years by holding a bigger dollop of riskier assets, and then stiffen the mix with more bonds towards the end so you’re less likely to have egg on your face when your pension pot comes out of the financial oven. [Tosses tortured metaphor to one side as it slips into unconsciousness.]
It’s hard to imagine an investment fund that can make life any easier than this.
- The fund offers a diversified, global asset allocation in a single product.
- It automatically rebalances that asset allocation for you.
- It gradually dials down the equities and dials up the bonds as you age – lowering your risk exposure as retirement draws nearer.
- It does almost everything for you bar filling out the direct debit.
All you have to do is decide when you’re going to retire.
Each Vanguard Target Retirement Fund comes with a target date that identifies the earliest year its investors are expected to retire.
For example, Vanguard Target Retirement Fund 2020 is aimed at investors who plan to flick the Vs to working life between 2020 and 2024, while the Vanguard Target Retirement Fund 2025 is just the ticket if you’re planning to hold your F.U. party between 2025 and 2029.
And on we go in five-year steps out to the impossibly futuristic Vanguard Target Retirement Fund 2055 – by which time The Investor will be tapping out posts with his cyber fingers and I’ll be an upload in The Cloud.
If you’re a forward-thinking 15-year old who’s already dreaming of a life on a Martian golf course from 2060, then no doubt Vanguard will soon be releasing a fund for you, too.
At this point, I should point out that the Target Retirement Funds are passive investor friendly:
- They invest in an underlying selection of Vanguard index funds.
- They are cheap. The Ongoing Charge Figure (OCF) is expected to be 0.24%.
Taken together the Target Retirement Funds are like cars on an asset allocation rollercoaster that careers downhill from peak equity to the bond flats below.
The asset allocation ride looks like this:
Vanguard’s example supposes the journey starts at age 25 and ends with retirement at age 68.
- Equity allocation is 80% for the first 18 years up until age 43. The other 20% is in bonds.
- The portfolio gently derisks until you are 50:50 equities to bonds by age 68.
- There’s a steep decline over the next seven years until you’re 30% equities, 70% bonds.
- At that point, the asset allocation flatlines. It remains 30:70 in favour of bonds for as long as ye shall live (or your money lasts).
Of course, the fund trundles on regardless of what age you are when you hop aboard.
The Target Retirement Fund 2015 is split 50:50 (at the time of writing) so that would be your initial asset allocation if you piled into that fund right now, regardless of whether you happen to be 21 or 97. Over the next six years it will glide down to 30:70.
This means that even if you’re a glamorous showbiz personality who has spent a lifetime fibbing about your age, you should be honest with yourself when you’re deciding which fund is right for you.
Frankly, the approach offered by Vanguard’s new funds is all very reasonable and based on a standard investment technique known as lifestyling.
The idea is you load up on equities when you’re young and time is on your side, to benefit from their historic knack of outperforming bonds over the longer term.
Then you gradually store more of your wealth in bonds – which are less apt to lose half their value in the blink of an eye – reducing the chance of your gravy train being wrecked just as you were about to put your feet up.
The reality is that it will depend on your individual circumstances and unknowable future investment returns.
But lifestyling is a perfectly sound theory and it makes a great deal of sense, particularly if you don’t have the time, knowledge or temperament to manage your own investments.
It’s also reassuring that Vanguard is happy to lay down its methodology cards on the table.
Vanguard manages the finer points of the asset allocation for you.
The following pic colours in the detail:
At the start of the journey (left-hand side of the graph) you’ll be in:
- 20% UK equity (yellow)
- 60% Global equity ex-UK (magenta)
- 5% UK nominal bonds (blue)
- 15% Global ex-UK bonds (green)
Five years before retirement, UK index-linked gilts (cyan) come into play to help protect the portfolio from inflation.
By the time the glidepath touches down at age 75 your final asset allocation is:
- 10% UK equity (yellow)
- 20% Global equity ex-UK (magenta)
- 2.5% UK nominal bonds (blue)
- 17.5% UK index-linked gilts (cyan)
- 50% Global ex-UK bonds (green)
Again, it’s all perfectly sane.
The main debating points are:
- There is home bias in the allocation to UK equities, which makes increasing sense as you come to retire and want to dampen currency risk.
- The bond allocation includes global bonds and corporate bonds to diversify returns in this era of ZIRP (Zero Interest Rate Policy). But none of yer junk bonds or emerging market ones.
- The global bond funds are rightly hedged to reduce currency risk. Meanwhile the non-government bond allocation of the 2015 fund is approximately 15% – so not worryingly excessive.
- Emerging market equities are underweight, representing 8.5% of the equity allocation in the far-out funds and 5.6% of equity in the near-term 2015 fund.
Personally, I’d prefer a heftier index-linked gilt allocation (it maxes out at 30% of the bond allocation), no corporate or global bonds and more emerging market equities in my mix.
But if I couldn’t be bothered to going to the trouble of managing it myself then I could happily live with Vanguard’s broth.
Temptingly, the index-linked gilts are short-dated (0-5 year maturities) which makes them less exposed to interest rate hikes knocking lumps off your capital value.
Lower volatility options like that are ideal as you come to retire and there’s currently no short-dated index-linked alternative available as a separate tracker fund.
Pros and cons
The most obvious danger is that being young is no guarantee that you can hack an 80% equity allocation.
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 take care to check its asset allocation serves your needs as you countdown to retirement.
If you go for a 50:50 split 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.
The other big danger comes from relying so heavily on Vanguard’s auto-pilot 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.
That will happen if:
- Your fund meets or exceeds its expected returns…
- …while you put enough money in…
- …over a long enough period of time.
If performance is falling short, human intervention is needed in order to up your contributions, extend your timeline, or reduce your needs.
A few smaller cons:
1. 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.
2. You can buy cheaper. The underlying components of the 2055 fund can be bought in the same proportions for 0.14% per year rather than 0.24% in management fees. That’s a 32% discount for self-management, assuming you don’t pay dealing fees on fund transactions.
Naturally that has to be set against the hassle factor and the chimp factor – that is, the fair chance you’ll self-sabotage at some point because we’re all barely down from the trees in investing terms.
3.There’s no tilt to property, nor any of the factors that can further diversify a portfolio.
But 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. I would happily put every last one of them in a Target Retirement Fund.
The alternative is likely to be much worse.
Take it steady,
P.S. Vanguard has occasionally made changes to the US version of the formula in response to market conditions. It previously increased the equities allocation and also broadened international exposure to equities and bonds. If you’re buying into the Target Retirement Funds for convenience – rather than because you have strong views – then you’ll probably be glad someone is keeping an eye on things, but beware.