The Vanguard Target Retirement 2040 Fund Can Help Generation X Invest the Right Way

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The Vanguard Target Retirement 2040 Fund is a target-date retirement fund designed for investors planning to retire between 2038 and 2042. A popular 401(k) fund, this target-date fund has a low expense ratio and automatically shifts its strategy over time.

What is a target-date fund?

A target-date fund, also known as a lifecycle or age-based fund, is intended to provide investors with one simple choice for retirement investing.

Stock-based funds have high long-term return potential but also come with 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 funds automate this process for investors. Over time, they gradually shift their holdings from growth-oriented stock funds to a more income-oriented retirement portfolio of bonds.

The Vanguard Target Retirement 2040 Fund: Present and future

Assuming an average retirement age of 65, this fund's intended demographic consists of people who are roughly between 39 and 43 years old in 2016, although this can vary considerably for investors who plan to retire at a significantly younger or older age.

The structure of the fund is simple. It invests client's assets in four Vanguard index funds:

  • Vanguard Total Stock Market Index Fund (53.2% of assets as of 5/31/16)
  • Vanguard Total International Stock Index Fund (35.4)
  • Vanguard Total Bond Market II Index Fund (7.9%)
  • Vanguard Total International Bond Index Fund (3.5%)

So the fund has about 89% of its assets in stocks and 11% in bonds. This makes sense -- after all, these investors are still over 20 years away from retirement, so the priority is growth as opposed to capital preservation and income.

Over time, this allocation will change, and we can get a good idea of what this fund may look like by examining some of Vanguard's other target-date retirement funds. For example, Vanguard's 2030-targeted fund is (theoretically) what the 2040 fund should look like in 10 years, and is currently made up of 74% stocks and 26% bonds. In 2040, when these investors are ready to retire, we can expect a roughly 50/50 mix, as is the case with the 2015-targeted fund.

The fund will continue to adjust for approximately seven years after the target date is reached, at which point the fund's holdings will match those of the Vanguard Target Retirement Income Fund , which is composed of roughly 30% stocks and 70% bonds, and has an annual yield of 1.8% as of this writing.

Because the assets are passively invested in other Vanguard funds, there are no management fees or any other additional charges associated with the fund. The only cost of investing in the fund is the 0.16% acquired expense ratio that is passed along from the four investment funds.

Is it right for you?

If you prefer to put your retirement saving on autopilot, target-date funds from Vanguard are a great way to do it.

However, it's worth noting that the specific date isn't set in stone. Even if you plan to retire around 2040, you can choose to invest a bit more aggressively by choosing another fund with a target of 2045 or even 2050. Similarly, you could choose to take a more conservative approach with a 2030 or 2035 targeted fund.

The point is that the Vanguard Target Retirement 2040 Fund is designed to appropriately allocate assets for the average investor who plans to retire between 2038 and 2042. It's important to consider your own situation and risk tolerance before investing to determine if it's right for you.

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