Why Vanguard Target Date Funds Are the Best in the Business

By Markets Fool.com

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Vanguard target date funds are excellent retirement savings choices, with lower fees than Fidelity Freedom Funds or T. Rowe Price's target date funds. Vanguard's target retirement funds invest in other Vanguard mutual funds, such as the Vanguard Total International Stock Index Fund, and gradually shift from stocks to bonds as the target date nears.

About target date retirement funds

There are two main categories of mutual funds retirement investors choose from stock funds and bond funds.

Stock-based funds have high long-term return potential but also have relatively high volatility. On the other hand, bond funds are more stable, especially in terms of income, but don't have the long-term potential of stocks. Therefore, it's generally suggested that younger investors put most of their money into stocks and gradually shift their investments into bonds as they get closer to retirement.

Target date retirement funds are mutual funds that are designed to automate this process and be the only fund retirement investors need. These invest in other stock- and bond-based mutual funds and gradually shift investors' asset allocations from stocks to bonds as the retirement date nears.

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How Vanguard's target date funds work

Vanguard's target date funds invest clients' assets in broad Vanguard index funds, gradually shifting the allocation from stock funds to bond funds over time.

For example, consider the Vanguard Target Retirement 2030 Fund . This target date fund invests its assets in a combination of four Vanguard index funds, in the following proportions (as of 5/31/16):

  • Vanguard Total Stock Market Index Fund (44.3%)
  • Vanguard Total International Stock Index Fund (29.4%)
  • Vanguard Total Bond Market II Index Fund (18.3%)
  • Vanguard Total International Bond Index Fund (8%)

So, about 74% of this fund's assets are in stocks, with the other 26% in bonds. By looking at the allocations of Vanguard's other target-date retirement funds, you can see how this mix can be expected to shift over time. The funds' allocations keep adjusting for about seven years after the target retirement date, at which point they'll be in the same proportions as the Vanguard Target Retirement Income Fund

Target Retirement Date

Current Stock Allocation (%)

Current Bond Allocation (%)

Acquired Expense Ratio (%)

2060

90%

10%

0.16%

2055

90%

10%

0.16%

2050

90%

10%

0.16%

2045

90%

10%

0.16%

2040

89%

11%

0.16%

2035

82%

18%

0.15%

2030

74%

26%

0.15%

2025

67%

33%

0.15%

2020

59%

41%

0.14%

2015

49%

51%

0.14%

2010

34%

66%

0.14%

Vanguard Target Retirement Income Fund

30%

70%

0.14%

Data Source: Vanguard Target Retirement Funds Prospectus (January 28, 2016)

I'd like you to notice couple of things from the data in the chart. First of all, notice that no matter how far away from retirement, the fund is never 100% in stocks. Similarly, the fund never shifts 100% to bonds. This is an important concept -- your portfolio needs some exposure to the stability of bonds and the growth potential of stocks at all times.

Also, notice how the 90/10 mix is sustained until the investors are about 25 years away from retirement. In other words, young investors who buy the 2060 target fund can expect to be about 90% invested in stocks for the next 20 years or so, to maximize the long-term growth power of stock investing.

Comparing the costs

In the last column of the chart, you can see the acquired expense ratio for each fund. It's labeled as "acquired," because these funds don't charge investors anything directly -- since assets are invested in other Vanguard funds, the expense ratios from those funds are simply passed along to the target date funds' investors.

As you can see, Vanguard's average acquired expense ratio is approximately 0.15%, well below the industry average of 0.43%.

For a direct comparison, Fidelity's Freedom Funds have gross expense ratios of 0.23% to 0.24% for those choices that invest in index funds. It's worth mentioning that Fidelity also has target-date funds that don't exclusively stick to index funds with expense ratios in the 0.75% ballpark. Since the strategy is different, these aren't apples-to-apples comparisons with Vanguard's target date funds, but be aware that this option is out there. T. Rowe Price is another popular provider of target date funds, and its offerings are all of the non-index-fund variety and come with expense ratios between 0.58% and 0.75%.

The reality is that most actively managed mutual funds don't beat the market over long periods, so I tend to lean toward the index fund variety when it comes to retirement investing, therefore I consider Vanguard's funds to be the best deal.

The bottom line on Vanguard's target date funds

If you're looking for a one-stop retirement savings option, a target date fund is a smart way to get one. Vanguard's options are easy to understand and have the lowest costs in the industry, making them excellent choices for investors who want to put their retirement savings on autopilot.

The article Why Vanguard Target Date Funds Are the Best in the Business originally appeared on Fool.com.

Matthew Frankel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.