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

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?