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Vanguard Target Retirement Funds Explained

There has been some interest in an explanation of how the Vanguard Target Retirement Funds work since I mentioned them in an explanation about Mutual Funds in a past article (read The Beauty of Mutual Funds [3]). In this article, I’ll give you a little explanation of how these funds work and what you might expect from them (past performance is not an indicator of future performance!).

They’re in the asset class titled “Lifecycle” by Vanguard and several other brokerage houses have very similarly structured, lifecycle mutual funds (Fidelity has the Fidelity Freedom Funds if that rings a bell). The concept is as the target date draws closer, the fund will invest in increasingly stable investments that have higher yields. Vanguard recommends the lifecycle funds for those seeking “an all-in-one retirement portfolio that automatically grows more conservative as their expected retirement date nears…”

In looking at the fund’s performance and yield, the trend behaves as you would expect. The Retirement Income (which you would purchase if you are already retired) has the highest yield of 3.75% and the lowest average annual total return of 3.96%. The Retirement 2045 (the one with the farthest horizon) has the lowest yield at 1.34% and the highest average annual total return of 9.12%. The remaining funds trickle in between the two at rates you’d expect given the risk characteristics of the funds. And performance since inception? The same trends you’d expect are reflected with the Income coming in at 6.85% and the 2045 coming in at 15.79%.

The Target Retirement funds are simply holdings, in varying percentages based on risk tolerance, of other Vanguard funds. The table below is a percentage of holdings as of 1/31/05 of several of the funds.

Fund “Date” Income 2005 2025 2045
Total Bond Market Index 50.0% 49.9% 40.9% 10.9%
Total Stock Market Index 20.1% 33.0% 47.4% 71.1%
Inflation-Protected Securities 24.9% 16.4% 0.0% 0.0%
Prime Money Market 5.0% 0.7% 0.0% 0.0%
European Stock Index 0.0% 0.0% 8.3% 12.5%
Pacific Stock Index 0.0% 0.0% 3.5% 5.3%

As you can see from the table, the Income and 2005 are more conservative than the 2045 and even the 2045. The first two don’t touch Europe and the Pacific while the 2045 has nearly 20% overseas.

So we’ve talked about their performance, but what about their expense ratios? Each one clocks in at 0.21% to 0.22%, which is low, about on par for index funds. Look at the Vanguard 500 Index Fund has an expense ratio of 0.18%, you can be pretty confident that Vanguard isn’t fleecing you on fees for these Retirement funds. Now, these funds are “Funds of Funds” which in some cases may mean the expense ratio listed is charged on top of the expense ratios of the underyling funds. This is not the case with the Target Retirement funds, the expense ratio is the weighted indirect expense ratio. There is a footnote in the prospectus that does state “Although the Fund is not expected to incur any net expenses directly, the Fund’s shareholders indirectly bear the expenses of the underlying Vanguard funds in which the Fund invests.”

Again, if you are interested in these or other Vanguard funds, request a prospectus! Read all about it before you invest and see if they’re for you. And please don’t read my views on these funds as a recommendation to buy into them, I’m just boiling down all the facts available on Vanguard’s site in one easy place. And I invite one and all to comment on my thoughts of the Target Retirement funds (too conservative even with the 2045?) and look forward to them.