Target Retirement Funds: Perfect For After 401k & Roth IRA?

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Last week, reader AJ sent me an email asking for ideas on where he should be putting his savings once he’s maxed out the contributions to both his 401(k) and Roth IRA. He’s 23, employed in real estate, and has fully funded his emergency fund and was wonder where he should go next.

Question: I’ve been sold on the wisdom of buying index funds and I would like to take a portion of that savings account and buy at least 3 different index funds (total stock fund, total bond fund, and a total international fund.) Reason being, I do not want to be wholly in stocks, be it domestic or internation, or bonds. However, the minimum investment is $3000 per fund at Vanguard. So at the very minimum I would have to spend $9000 to begin which is not the problem. However, if I stopped there, my allocation would be all out of whack. I’d be 33% in domestic, 33% in foreign, and 33% in bonds.

At my age, those allocations do not make sense. (Bonds and foreign, I think are too high of a percentage.)

Any suggestions – short of buying enough of each to make the proper allocations?

I told AJ that his situation and my situation are very similar, I’m not 100% sure what to do with the excess funds (not a bad problem to have!) and right now my solution is to have it in a target retirement fund at Vanguard. Now, that puts a heavy skew on stocks vs. bonds, which isn’t necessarily a bad thing. For example, VTIVX (TR 2045) is 88.27% stocks, 9.76% bonds, and it has an expense ratio of 0.21%. VTSMX, the total stock market index fund of Vanguard, has an expense ratio of 0.19%, a difference of 0.02%. The target retirement funds basically aggregate the fees of its constituents without adding anything onto them, which is great.

In terms of domestic and international exposure, you can only get at that if you look at the components of the retirement fund. The top ten holdings are: (from Google Finance)
Vanguard Total Stock Mkt Idx: 69.83%
Vanguard European Stock Index: 10.52%
Vanguard Total Bond Market Index: 10.04%
Vanguard Pacific Stock Index: 4.73%
Vanguard Emerging Mkts Stock Idx: 2.88%
Vanguard Total Stock Market ETF: 1.99%

So you’re talking essentially 82% domestic, 10.5% european, 5% asia, and 3% everything else (you’ll have to dig deeper into each fund to know for sure). Either way, a TR fund might be the easiest route to go.

However, if you want greater control and flexibility, i think your approach of selecting a basket of funds from vanguard’s offering is a good one. You’re essentially doing what these TR funds are doing, except manually, and you aren’t going to be charged more or less in either scenario.

One main reason I chose TR funds was because it was easy. 🙂

To which AJ responded with:

Ah, the target retirement fund. What an invention! All my contributions to my Roth IRA are invested in VFIFX, the TR 2050.
I could just put all my excess money ALSO into VFIFX, but for some reason I shied away from doing that. But, it seems, now that I think about it further, that I didn’t/don’t have a good reason for that aversion….

In addition to the fact that it’s comprised of index funds (diversification element #1), it also invests in different TYPES of index funds: stock (domestic and foreign), bond, among others (diversification element #2). Which would solve my problem of having to invest over $20k in order to get the same diversification in picking individual funds…

Hmm… maybe my hesitancy was based on “not putting all my eggs in one basket?” Which really doesn’t apply here because of the above, right? Complicated.

I told him that I had the same reaction when I decided to invest some of my Roth into the TR2045 too, I just felt odd putting so much into one fund but the fund is diversified. I guess it’s just a reaction to the idea that it’s one stock ticker, not so much the underlying factors. I think the eggs in one basket doesn’t apply but I think the reaction is very natural (mostly since I reacted that way too!).

It’s hard to decide what to do because there isn’t much guidance out there and the guidance out there isn’t necessarily right for everyone. Once you get past 401k and Roth, it’s pretty much wide open because very few people have the ability to save beyond 20k a year strictly for retirement (if you subscribe to the idea you should contribute your 401k to the max). Plus, there are so many people within the min max/Roth max bucket that catering to those outside of it doesn’t seem to pay for mainstream media.

That being said, I think a target retirement fund is a good idea but that’s because it’s easy. You might want to consider other assets other than stocks and bonds, perhaps investing into other things like gold, jewelry, real estate or art (I know nothing about it, just throwing out some of the more non-standard investment instruments) might be worth investigating. It all depends on how much time and interest you’re willing to spend, plus how much you’re willing to risk.

What do you all think? What would you recommend for AJ?

{ 9 comments, please add your thoughts now! }

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9 Responses to “Target Retirement Funds: Perfect For After 401k & Roth IRA?”

  1. Bob says:

    While I really don’t have an issue with this idea, it may cause some issues down the road.

    Given that AJ wants a set allocation spread between domestic/international/bonds, he could decide on whichever TR best matches this allocation and go with it. The issue I see in the future however, is the TR allocation changes over time, which may cause the allocation to veer from what AJ wants. Another option could have been the Life Strategy family. They have a fixed allocation that doesn’t change, invest mostly – but not wholly – in index funds, but they don’t have international exposure, so they’re disqualified from AJ’s possibility list.

    If the investment time horizon is 5 years or less, and the total account balance is going to stay rather low, then I’d say go for it – good idea to improvise your way around funding three accounts. But if the money is going to be invested for a longer period of time and/or the account balances will grow to a sizable amount – then you’ve got issues with an allocation that doesn’t match your preference and having to liquidate – possibly paying sizeable capital gains tax bills – to divest and re-invest into your preferred allocation. Of course, you could keep this fund and invest new dollars into another fund, but I’d find that rather cumbersome…

  2. Dan says:

    Out of curiosity, when do you hope (or plan) to retire? If you invest in a target fund like this and hope to get out of the game before 60, what happens to all these investments?

  3. Tim says:

    the problem with the here logic, is that he is thinking of only about the three funds he is currently thinking about purchasing. He needs to think about his whole portfolio, which includes existing 401k/IRAs/cash, when determining asset allocation. So, the $9k isn’t going to make your whole asset allocation 1/3, 1/3, 1/3, unless you already have that breakdown for the rest of his portfolio. determine what your asset allocation is, and adjust the $9k towards the fund class that will balance out your portfolio.

  4. Tia Stevens says:

    Hi Guys,
    I’m from Malaysia, staying in Kuala Lumpur. We do have shares but shares in Malaysia do not move fast enough to make an impact on small investment. However, after saying that it is definately better then keeping in the back.

    The inflation rate is about 4.1% and our fixed deposit is only earing 3%. The rest is all eaten up by inflation.

    Our choice of making money is still Property. Yes, that’s right, landed property.
    For every 1USD is equivalent to RM3.50. We buy good location, do it up, put it on the market. A good location property can help you to easily fetch minimum 100 to 300%. By the way, I’m a real estate agent myself. Most of the foreigners or expatriate will buy good unit for investment and rental too.

    Cost of living here is pretty affordable. A take away meal called nasi lemak can be as cheap as RM1.20 which is 0.34cents. Can you get a meal for USD 0.34 cent?

    Ecomomy is stable, no hurricane, no earthquake, no tornando, good political country which is democratic in nature. Our neighbour is Singapore and Thailand. Check Malaysia out and we are a multi racial country with plenty of Chinese, Indians and Malay plus a lot of expatriate living here as a second home. We are very tolerant of each other culture, food and believes………..

    Any one been here before????

  5. saladdin says:

    I never have been to Malaysia but I glad to see that “fetch” is not just a southern word.


  6. Patrick says:

    I think it is a good plan for simplicity’s sake, but as someone mentioned, you have to take into account future needs because the plan’s allocation changes with time. If you are happy with those changes, then that’s fine. If you aren’t happy with those changes, you have to consdier how to reallocate to meet your needs. For your retirement funds, it is not an issue because you will not owe taxes on a ny gains until you withdraw your funds. But for taxable accounts, rebalancing could be an issue. To avoid the process of selling and paying taxes, you could just leave it as is and place future investments into a different fund to balance it how you want. But, within the first few years I wouldn’t think most people would want to make too many major changes to their allocation if everything is in a fund they are happy with.

  7. Meg says:

    Well, he doesn’t mention any other savings besides a “full” emergency fund. But does he have enough cash to buy his next car? An engagement ring? A home? Anything else he might need/want in the next 2-5 years? He doesn’t want to set himself up to have to liquidate a stock mutual fund in order to buy those things.

    Assuming he really does have enough cash for everything he might want in the next 5 years, I would also recommend the VGTR2045. Although he might want to consider the VG LifeStrategy Growth fund as well. It’s very similiar to the TR2045 except that the asset allocation won’t change over time–and it’s a little more aggressive with only about 10% in bonds.

  8. AJ says:

    Just to keep you posted:

    Thanks for the comments! I ended up just buying more of the TR 2050, for the reasons mentioned above.

    Happy investing!


  9. Target Retirement funds are great if you are unsure how to invest your money. They provide solid diversification at a low cost. However, you won’t get some very valid asset classes by using these funds. Specifically, REITs, commodities, inflation protected and foreign bonds are usually ignored.

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