Deciding which mutual funds are appropriate for a retirement portfolio requires a good understanding of investment strategies that may need to change over time.
Vanguard target-date funds do the research, selection, and rebalancing of securities so investors don't have to. The funds start with an allocation that favors stocks in the early 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%. That's 84% less than the industry average. Beginning in February 2015, Vanguard increased the international equity and fixed income allocations for its target retirement funds to provide investors with improved global diversification.
- Target-date funds can simplify retirement investing for investors by rebalancing their asset allocations over time to allow for less risk.
- The longer the time that an investor has until retirement, the more aggressive a fund's investment mix will be.
- The closer an investor is to retirement, the more conservative a fund's investment mix will be.
- The Vanguard Target Retirement 2055 Fund has a long-term time horizon and therefore has a greater allocation of equities.
- The Vanguard Target Retirement 2025 Fund is close to its target date and therefore has a large allocation of fixed income investments.
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 2055 or 2060. Such a target-date fund would normally have a large allocation of stocks and a small allocation of fixed income. 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 that for 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 years.
Below we take a look at three Vanguard funds for retirees. Except where noted, all figures are as of March 31, 2022.
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 34.70% allocation in domestic stocks, a 22.70% allocation in international stocks, a 27.60% allocation in U.S. corporate and Treasury bonds, and a 12.20% allocation in international bonds. The fund also has a 2.80% allocation in short-term inflation-protected securities. Domestic equity holdings of this fund are broadly diversified across the entire U.S. equity market.
Over the years, Vanguard target retirement funds have put more focus on higher-quality bonds and Treasury inflation-protected securities (TIPS) compared to other fund families. This approach can provide better protection of capital against volatility and real value erosion.
The Vanguard Target Retirement 2025 Fund has a four-star rating from Morningstar. It has an expense ratio of 0.08%, as of Feb. 12, 2022. This target-date fund has a 10-year return of 8.04%. 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.
Newly added funds
For those entering the workforce and expecting to retire in 40 to 45 years, Vanguard now offers target retirement funds with the target dates of 2060 and 2065.
2. The Vanguard Target Retirement 2040 Fund (VFORX)
The Vanguard Target Retirement 2040 Fund offers a one-stop, broadly diversified portfolio with a target date between 2038 and 2042. Like other Vanguard target retirement funds, this fund invests in four Vanguard index funds with asset allocations of 80.4% in equities and 19.6% in corporate and sovereign bonds.
About 49% of the fund's assets are allocated to domestic equities, while 31.8% are dedicated to international equities. There is a 13.6% allocation in U.S. corporate and Treasury bonds and a 6% allocation of international bonds. As the fund is close to 20 years away from its target date, it will continue allocating more assets to risky securities during the next five to 10 years.
The Vanguard Target Retirement 2040 Fund has an expense ratio of 0.08%, as of February 12, 2022, and a four-star rating from Morningstar. Due to Vanguard's heavier emphasis on international bonds and international equities, the fund provides broader diversification and better return prospects in the long run, as overseas markets—especially emerging markets—tend to grow faster compared to developed markets.
The Vanguard Target Retirement 2040 Fund has a 10-year return of 9.85% and a minimum investment requirement of $1,000. It's most appropriate for investors who plan to retire between 2038 and 2042 and who'd like to invest in one fund that manages rebalancing until their retirement.
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 started their careers in recent years and have over 30 years before retirement.
As the fund is still far from its target date, 89.01% of its assets are allocated to domestic and international stocks. The remaining 10.99% of its assets are split between U.S. and international bonds. The fund is likely to stick to such aggressive allocation until 2030-2035. 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%, as of February 12, 2022, and a four-star rating from Morningstar. Its 10-year return is 10.21% and it's 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 between 2053 and 2057.
- The Vanguard Target Retirement Funds typically extend about seven years beyond their target dates.
- Target retirement funds may be ideal for investors who prefer a hands-off approach to their investing.
- 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.
- Target retirement funds offer simplicity and convenience with their instant diversification and automatic asset allocation rebalancing. However, high fees can eat away at returns over the long term. So it's important to monitor them. Vanguard's funds for retirement all offer the same, low expense ratio, which keeps more of your money working for your retirement goals.
- 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.
- Consider all 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 a very aggressive allocation in equities.
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. 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 investors the benefit of diversification, the simplicity of one-stop shopping for a blend of equities and fixed income, and the convenience of automatic asset allocation rebalancing.
Vanguard's three best target retirement funds add to those advantages with their professionally managed asset mix, low expense ratios, and attractive minimum investment requirement.