Deciding which mutual funds are appropriate for a retirement portfolio requires a good understanding of investment strategies that may need to change over time.
Target retirement funds may be ideal for investors who prefer a hands-off approach to their investing. They offer investors the benefit of diversification, the simplicity of one-stop shopping for a blend of equities and fixed income securities, and the convenience of automatic asset allocation rebalancing.
Vanguard target-date funds do the research, selection, and rebalancing of securities so investors don't have to. With their asset mix, low expense ratios, and low minimum investment requirements, they're for people who would like to invest in one fund that manages rebalancing until their retirement.
The funds start with an allocation that favors stocks in theearly years of an investor's long-term time horizon. That means an allocation of approximately 90% stocks and 10% bonds. As an investor progresses through their career, Vanguard gradually rebalances its target retirement fund's asset allocation in favor of less risky securities, such as bonds and short-term reserves.
Vanguard target retirement funds come with an average expense ratio of 0.08%. According to Vanguard, the industry average is .48%.
Key Takeaways
- Target-date funds simplify retirement investing by rebalancing asset allocations over time to allow for less risk.
- The closer an investor is to retirement, the more conservative a fund's investment mix will be. The more distant retirement is, the more aggressive a fund's investment mix will be.
- The Vanguard Target Retirement 2025 Fund is close to its target date and therefore has a large allocation of fixed income investments.
- The Vanguard Target Retirement 2055 Fund has a long-term time horizon and therefore has a greater allocation of equities.
Target Retirement Funds
A target retirement (or target-date) fund is a mutual fund that's specifically designed to change its asset allocation over time, as investors move through their working years. The fund's risk profile changes to align with investors' changing tolerance for risk.
For example, a younger investor with decades to go before retiring might consider a fund with a target date of 2060 or 2065. Such a target-date fund would normally have a large allocation of stocks and a small allocation of bonds. That's because, with a long time horizon, it makes sense to invest more heavily in higher-risk securities that offer the opportunity for high returns.
As time passes, the target retirement fund's more aggressive mix of securities will change. The allocation of bonds will increase gradually while the allocation of stocks will decrease. This change reflects the need for more conservative, less risky securities as the investing time horizon becomes shorter.
The Glide Path
A fund's glide path is the way that the asset allocation changes during the time it takes the fund to reach its target date. All target retirement funds alter their allocations from more aggressive to more conservative. However, the transition for some ends once a target date is reached. Others continue rebalancing their allocations for a number of years past the target date, slowing the shift from growth-focused securities to fixed income securities. This glide path addresses the need for some growth, and not simply preservation of wealth, during retirement.
Below, we take a look at three Vanguard target retirement funds.
1. The Vanguard Target Retirement 2025 Fund (VTTVX)
The Vanguard Target Retirement 2025 Fund has a target date that ranges from 2021 to 2025. Because the fund is very close to its target date, its portfolio has a large number of bond holdings, which tend to be less risky when compared to stocks.
In particular, the fund invests in various Vanguard equity and bond funds, resulting in a 31.80% allocation of domestic stocks, a 21.30% allocation of international stocks, a 28.60% allocation of U.S. corporate and Treasury bonds, and a 12.40% allocation of international bonds. The fund also has a 5.90% allocation of short-term inflation-protected securities. Domestic equity holdings of this fund are broadly diversified across the entire U.S. equity market.
The Vanguard Target Retirement 2025 Fund has a four-star rating from Morningstar. It has an expense ratio of 0.08%. This target-date fund has a 10-year return of 6.31%. Its investment minimum is $1,000. This fund is most appropriate for investors who seek low fees and plan to retire between 2023 and 2027.
For those entering the workforce and expecting to retire in 45 years, Vanguard offers a retirement fund with the target date of 2070.
2. The Vanguard Target Retirement 2040 Fund (VFORX)
The Vanguard Target Retirement 2040 Fund offers a one-stop, broadly diversified portfolio for investors who plan to retire between 2038 and 2042.
Like other Vanguard target retirement funds, this fund invests in Vanguard index funds with asset allocations of 76.94% in stocks, 22.19.% in bonds, and .87% in short-term reserves. 47.5% of the fund's assets are allocated to domestic equities, while 30.1.% are dedicated to international equities. There is a 15.6% allocation of U.S. corporate and Treasury bonds and a 6.8% allocation of international bonds. The fund is about 15 years away from its target date.
The Vanguard Target Retirement 2040 Fund has an expense ratio of 0.08%, and a four-star rating from Morningstar. Due to Vanguard's emphasis on international bonds and international equities, the fund provides broad diversification.
The Vanguard Target Retirement 2040 Fund has a 10-year return of 7.95% and a minimum investment requirement of $1,000.
Different funds with the same target date can have different asset allocations in stocks and bonds. Make sure the fund that interests you has an asset allocation that matches your tolerance for risk and need for growth.
3. The Vanguard Target Retirement 2055 Fund (VFFVX)
The Vanguard Target Retirement 2055 Fund offers life-cycle asset allocation for investors with long-term retirement dates. This fund is attractive for investors who have 30 years before retirement.
As the fund is still far from its target date, 89.63% of its assets are allocated to domestic and international stocks. 9.70% of its assets are split between U.S. and international bonds and .67% are short term reserves. The fund is likely to stick to this type of aggressive allocation for several years. After that, it will start smoothly adjusting its allocation every year toward bonds.
The Vanguard Target Retirement 2055 Fund has an expense ratio of 0.08%, and a four-star rating from Morningstar. Its 10-year return is 8.51% and its minimum investment is $1,000.
This fund is most appropriate for investors who desire automatic asset rebalancing at a low cost and who are not planning to retire until 2051 to 2055.
The activity in target retirement funds can result in tax consequences for investors. Consider investing in a target retirement fund through a tax-advantaged account.
How Do Target Retirement Funds Work?
Target retirement funds are long-term investments that offer an asset allocation designed to change over time. They automatically rebalance from a more aggressive growth stance toward a more conservative one as the years pass.
These funds invest in a larger allocation of higher-risk securities for higher returns in earlier years. Then, with time, funds gradually transition to a wealth-preserving mode by allocating more to less risky fixed income securities, such as bonds.
Are Target Retirement Funds Good Investments?
They can be. They offer the convenience and benefits of diversification. Plus, they provide smart, automatic rebalancing of their asset allocations to match investors' changing risk tolerance.
Investors who have just started their careers could have an allocation that aggressively seeks growth and high returns. As their careers progress, their target retirement funds will rebalance allocations of assets to focus on less risky securities and protect value. Of course, no investment is without risk. Investors should plan to review their target retirement fund performance, allocation, and fees at least annually.
Are Target-Date Funds Too Conservative?
That depends on your tolerance for risk and when you plan to retire. Target-date funds will start out with a large allocation of higher-risk securities. As time passes, this should diminish as less risky, more conservative securities take up an increasingly larger percentage of the total allocation.
Finally, when the target date is met, the vast majority of the allocation will be in fixed income securities. If you prefer less conservative funds, you can seek out target-date funds that put a greater focus on equities throughout their glide paths.
The Bottom Line
Target retirement funds offer simplicity and convenience with their instant diversification and automatic asset allocation rebalancing. However, consider all of your investments when looking at a target retirement fund. For instance, if you already invest in fixed income securities, you might opt for a target retirement fund with an aggressive allocation in equities. And remember, high fees can eat away at returns over the long term. So it's important to monitor them. Vanguard's funds for retirement offer the same low expense ratio, which keeps more of your money working towards your retirement goals.
