Ask MAX: What does MAX think of the Vanguard Target Retirement Fund?

March 16, 2007

Dear MAX,

I am 26 and am staring an investment portfolio with $6,000. What do you think about Vanguard's Target Retirement 2045 Fund?

St. Louis, MO

Dear Ken,

Despite the fact that it sounds to us more like the title of Arnold Schwarzenegger's last movie than a mutual fund (YOU'RE TERMINATED AARP!), for a guy in your footloose-and-fancy-free shoes, we think Vanguard's Target Retirement 2045 Fund (VTIVX) is not a half-bad way to go.

Vanguard currently has six Target Retirement funds, ranging from the Target 2045 for investors who aren't planning on hanging it up for forty years or so, to the Vanguard Target Retirement Income Fund Summary, which is for those who are currently retired.

The idea behind the Target Retirement funds is that the funds adjust their allocation as you grow older. A young whippersnapper like you buys the fund today and your money is invested in a decidedly growth-focused 88% stocks and 12% bonds. In the next forty years, the fund's manager slowly lowers your equity allocation and increases your bond allocation. If you stuck with the fund for the long haul, by the time you reach your 'target retirement' date your investment’s allocation would flip to an income-focused 30% stocks and 70% bonds. A few years after retirement, the fund will resemble the Vanguard Target Retirement Income.

We like the idea of a set-it-and-forget-it fund for young Turks like you for a couple of reasons:

Twenty-somethings are notoriously negligent investors. They’re either so busy that they forget to invest altogether, or they sink all their money into stocks that are so risky that they may as well be plunking down their cash on a six-team parlay in Vegas.

Investing in the Vanguard Target 2045 Retirement fund on a regular basis is such an easy way to put your money to work that even Paris Hilton could do it. You don't need to spend any time researching or determining how much of your money should go into what type of fund. You write one check and you don't have to give your investment another thought until you want to. Better yet, enroll in Vanguards automatic investment plan and have a set amount deducted from your checking account and invested into the fund each month, automatically.

Vanguard's managers allocate your money in a risk-appropriate way, and adjust as time goes by. While some young people think that their investment portfolio literally can't be risky enough, even people in their twenties should have a well-diversified portfolio with some bond exposure. The Vanguard Target Retirement 2045 fund, like all the Vanguard Target Retirement funds, is a fund of funds, meaning it is a mutual fund that invests in other mutual funds. Like many fund of funds, the fund invests in funds from the same family only. The current 2045 fund allocation looks like this:

1. Vanguard Total Stock Market Index Fund 70.3%
2. Vanguard Total Bond Market Index Fund 11.9%
3. Vanguard European Stock Index Fund 11.9%
4. Vanguard Pacific Stock Index Fund 5.9%

As you can see, even the riskiest of Target funds has a full 12% of its allocation to bonds, and the equity portion is nicely diversified into U.S. and foreign markets. It’s an easy, instant, well-diversified portfolio, and with an expense ratio of just 0.21%, the price is right, too.

That said, we aren't as keen on the Vanguard Target funds, or fund of funds in general, for more experienced investors. Fund of funds can be expensive. The worst thing about mutual funds is that expenses are taken out of your investment returns, and a fund of funds adds an additional layer of expenses on top of those associated with the individual funds in its portfolio. While Vanguard's funds of funds are just about the cheapest around, others (usually the kind that buy funds from several fund families) have significant double-layer fees – the fund of funds itself, and the expenses of the underlying funds. Single-family fund of funds tend to be cheaper because they are happy making money on the underlying funds and are merely using the fund of funds as a conduit to their other funds.

The diversification decisions are, obviously, quite broad, and are not geared toward each investor’s individual situation. While most 35 year-old investors might be comfortable with a growth-focused portfolio, one who is planning to buy a house in the next few years should be a lot more careful with their money.

So, while the Vanguard Total Retirement 2045 fund might be a great place for a young investor to get started, in a few years we'd recommend you think about a more do-it-yourself solution.

Thanks for the question.


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