- Monevator - https://monevator.com -

Vanguard Target Retirement Funds – the Magimix of investing

The Vanguard Target Retirement Funds [1] are the state-of-the-art in investing convenience. They slice ‘n’ dice your money into a diversified [2] 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.

All you have to do is decide when you’re going to retire.

Target date

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 [6] friendly:

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:

204. Target retirement glidepath_vanguard [7]

Vanguard’s example supposes the journey starts at age 25 and ends with retirement at age 68.

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.

Lifestyle choice

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 [8] 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.

There is plenty of debate about whether this approach is right [9], wrong [10], defeatist [11], or optimal [12].

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 [13] cards on the table.

Global diversification

Vanguard manages the finer points of the asset allocation for you.

The following pic colours in the detail:

204. asset allocation glidepath [14]

At the start of the journey (left-hand side of the graph) you’ll be in:

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:

Again, it’s all perfectly sane.

The main debating points are:

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

Cons first.

The most obvious danger is that being young is no guarantee that you can hack an 80% equity allocation.

Theoretically, you’ve got years to recover if things go south [16]. But that’s cold comfort if you freak out and sell during a bear market because you’re in way beyond your risk tolerance [17].

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.

To get a feel for these issues, estimate your risk tolerance [18] or try this respected test [19].

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 [20] by its target date.

That will happen if:

If performance is falling short, human intervention [24] 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 [25] 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 [26] – 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 [27] 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:

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,

The Accumulator

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.