Stocks — Part XV: Target Retirement Funds, the simplest path to wealth of all

Posted: December 18, 2012 in Stock Investing Series

Ok, so you’ve read the Smoother Path to Wealth and thought,  “Aww man.  Three funds?  And I gotta rebalance them every year?  That’s too much to keep track of!”

Picard aww man

But then you hit the link and went to the Simple Path to Wealth.  As you read, you thought, “This is more like it.  Only one fund.  This I can handle.”  But then you got to the part where, maybe 40 years from now as you start looking at retirement, you’re going want to add a couple more.  “Aww man!”

jlcollinsnh hears your pain.  You need the simplest of all possible paths.  You need to be able to buy just one fund and own it till your dying day.  Any asset allocation crap should be handled for you.  You have bridges to build, nations to run, great art to create, diseases to cure, businesses to build, beaches to sit on.  Motorbikes to ride.  I’m here for you bunkie.

More importantly, so is Vanguard with a series of 11 Target Retirement Funds.* For that matter, so are other mutual fund companies, but as you know Vanguard is the primo choice around these parts so we’ll be talking about these. If your 401k or similar plan offers only one of the others, what is said here (excepting expense ratio costs) applies.

*(For some reason this link doesn’t stay set to just the Target Retirement Funds.  To bring them up when you get to the page, look at the left hand column.  Under Asset Class chose Balanced.  Under Fund Minimum be sure only $1000 is checked.  Under Management chose Index.  That should bring them up.  Then you can simply click on each to check out the specifics.)

If you click on the link you’ll see that these eleven funds range from Target Retirement 2010 to Target Fund 2060.  The idea is you simply pick the year you plan to retire and that’s your fund.  Other than adding as much as you can to it over the years and arranging for withdrawal payments when the time comes, there is nothing else you need ever do.  It’s a beautiful and elegant solution.

Let’s peek under the hood.

peek under the hood

Megan Fox wants to….

Each of these Target Retirement Funds (TRF) is what is known as a Fund of Funds.  That just means that the Fund holds several other funds, each with different investments.  In the case of Vanguard, the funds held are all low-cost Index Funds.  That’s a very good thing.  The TRFs ranging from 2020 to 2060 each hold only three funds:

  • Total Stock Market Index Fund
  • Total Bond Market Index Fund
  • Total International Stock Market Index Fund

To those three the TR 2015 fund adds:

  • Inflation-Protected Securities Fund

To those four the TR 2010 fund adds:

  • Prime Money Market Fund

As the years roll by and the retirement date chosen approaches the funds will automatically adjust the balance held, becoming steadily more conservative and safer over time.  You needn’t do a thing.

The expense ratios range from .17 to .19, depending on the fund.  Excellent.

What are the short comings?

Some people say the funds get too conservative too soon. Others complain that they are too aggressive for too long. For my money, I think Vanguard gets it pretty close to spot on.  Maybe a bit conservative for me personally, but then I’m on the aggressive side.  This is easy to adjust for.  If you want a more conservative (greater percentage of bonds) approach, choose a date before your actual retirement.  The earlier the date the more conservative the asset allocation.  If you want more aggressive (greater percentage of stocks), just pick a later date.

In deciding, be sure to remember what we learned looking at the Trinity Study in our discussion of withdrawal rates:  A strong dose of stocks is critical to a portfolio’s survival rate, especially once you begin drawing money out.

BTW, other fund companies use differing allocations for differing retirement dates. If those are what’s offered in your 401k or 403b plan, you’ll need to take a look and then decide. But the same principles apply.

So why doesn’t jlcollinsnh recommend them?

I do, actually, and am with this post.  They are an excellent choice for many, maybe most people.  They will certainly over time out perform the vast majority of active management investment strategies.

But I do have a slight preference for…

…the Smoother Path to Wealth and the Simple Path to Wealth.  Here’s why:

  • The expense ratios are even lower than those of the TRFs.
  • The TRFs all hold the Total International Stock Market Index Fund.  While this is an excellent fund, I don’t feel the need for additional international coverage beyond that found in the Total Stock Market Index Fund.
  • REITs are not part of the TRF mix. Held in VGSLX, these provide dividend income and, more importantly, serve as my inflation hedge.  Of course, you could easily just add VGSLX to your TRF of choice.
  • With separate funds, I can keep my bonds and REITS in my tax-advantaged accounts, protecting the dividends and interest from taxes.

Where are you likely to find Target retirement Funds?

looking under a rock

Painting by Ted Dawson

Target Retirement Funds have become very popular as options in the 401k and 403b retirement plans offered by employers. The thinking is (and it is sound) that most people really have very little interest in investing.  TRFs provide an effective, simple and well-balanced “one decision” solution.  Plus, because such retirement plans are tax sheltered, the interest from the bonds and the dividends from the stocks go untaxed.  Of course, when the funds are withdrawn in retirement taxes will be due.

What should you do?

If your 401k (or the like) offers TRFs or low-cost equivalents from another fund company, they are well worth your consideration.

If you want as simple as possible and still effective, TRFs are for you.

TRFs:  They come with the jlcollinsnh….

Seal-of-approval

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Comments
  1. Jim Partin says:

    What a coincidence! I was just reading the jlcollinsnh blog post about Vanguard TRFs and found it interesting as I have been considering rolling my AA terminated defined contribution retirement plan money into this fund. I like what I see with this fund as I really loathe the idea of paying 1-1.5 % of my assets to a financial planner to essentially do the same thing with asset rebalance as my risks tolerance decreases with age and nearer to retirement. Also, I have no aspirations of becoming a financial wizard myself, pilots have a way of ‘investing until it’s gone’ record when it comes to managing their money!

    • jlcollinsnh says:

      Hi Jim….

      Glad this post helped a bit in your personal analysis!

      If you haven’t already, read this one too: https://jlcollinsnh.wordpress.com/2012/06/06/why-i-dont-like-investment-advisors/

      As a pilot, you belong to a group of highly paid professionals who spend a lot of time learn and staying current in their own areas of expertise. Doctors, lawyers, engineers and the like are the same. Perfect targets for “advisors.”

      Recently I came across an article about insurance agents, masquerading as investment advisors (nobody wants to talk to an insurance agent), trying to sell life insurance as an investment. A horrible idea for the investor but, as describled by their sales trainer, “an obsenely profitable niche” for them. Profits that come out of the investors pocket, of course.

      They call their investors ELFs: Easy, lucrative and fun.

  2. […] no interest in managing our financial portfolio. So, with the realization that if I die tomorrow, the fund / asset allocations would never be adjusted unless I put it on autopilot, I opted to put our investments into target retirement funds for the ROTH IRAs, age based 529 plans […]

  3. Gypsy Geek says:

    Hi. Are you sure that internal rebalancing in a target retirement fund is not a taxable event? It is my understanding that it is, just as an actively managed mutual fund’s buying and selling within the fund is.

    Also, withdrawing from a 401k/IRA before 59.5 penalty free is possible due to the IRS’s 72t exemption. It does require fancy actuarial tables, etc, but it is possible. And even without the exemption, If you are in a high tax bracket such that the penalty and the tax rate coming out is lower than your rate during your working years, it’s also a bargain.

    For example, say you are in the 33% bracket during your working years, but expect to be in the 15% bracket afterwards. Even if you pay the 10% penalty, 10 + 15 = 25% is less than 33%. However, it may not make sense for everyone…

    • jlcollinsnh says:

      Thanks GG…

      and congratulations!

      You’ve caught me out in one of my biggest fears: Making a technical, factual error in one of my posts.

      You are absolutely right and I stand, with my hat off to you, corrected. The re-balencing of the funds in a TRF is indeed a taxable event just like the buying and selling of stocks in any mutual fund is, as you point out. I’ve deleted my incorrect paragraph from the post.

      In the 1.5+ years of writing this blog if I’ve learned anything it is that there are some very smart, well informed folks out there reading it. It is been a matter of pride, and no small amount of fact checking, that my stuff stands up to their scrutiny. But not always.

      You are also correct in that there are strategies for penalty free 401k/IRA withdrawals. Since I discuss this elsewhere I’m less distressed at you pointing out this one. :) As you mentioned, such strategies can be complex and overall my belief is most often most people are better served letting them ride until 59.5+.

      While my pride is wounded, I am genuinely grateful to you. It is important that folks feel confident in the factual accuracy of what they read here. If that means my ego takes the occasional well deserved hit, it is a small price to pay.

      Hope you keep reading and chime in anytime!

      • Gypsy Geek says:

        Don’t feel bad about the tax implications of target retirement funds. I wasn’t going to point it out, but I figured that someone may make the mistake of investing in them thinking they’re a free tax-ride.

        I am an avid reader of your blog, even though I never comment. I must confess that I have read every post you have written at least twice, especially the stock series. It is very refreshing to hear your optimistic, yet balanced view on life and investing.

        My wife and are on a early retirement path (we’re in our mid 30s). By mid next year we should have enough f-you money to to quit our jobs entirely, forever, but we enjoy our work enough to want to continue working. It is a great milestone (for me anyhow, my wife is completely unimpressed because she absolutely loves her job). The plan is for her to take a few months off next year so we can travel, since I work from home. Being free is a good feeling, and is in large part due to the advice from both you and MMM.

        Many thanks!

        • jlcollinsnh says:

          No worries GG….

          …. and my thanks to you for calling attention to it is genuine. It really is important that what I post be accurate. I don’t have a proofreader or fact checker, so I’m surprised I’ve done as well as I have.

          I’m honored you are reading the blog and so closely. Especially as you being able to pick out that error indicates you know your stuff.

          Congratulations on your great progress toward FI. My wife still loves her job, too! But at least it gives her lots of time off for our own travels.

          Make your way to New Hampshire and coffee’s on me!

  4. Shilpan says:

    Smart minds think alike. I started writing an article on Gone Fishin’ Portfolio several days ago. Since it’s entirely comprised on Vanguard funds, I decided to peek at your blog. And, here you are.. writing on the same topic, just notch better than me. John Bogle owes a big thank to my pal! Wait, we all owe a big thank to John. :)

  5. […] you have never heard of Vanguard funds, I recommend that you first dive deep into Jim Collins’s blog to know why he vehemently believes in Vanguard family of funds to build wealth for the long […]

  6. urbanfrugalist says:

    Here’s a better permalink for the Vanguard Target Retirement funds: https://personal.vanguard.com/us/funds/vanguard/TargetRetirementList

    Hope this helps!
    Joe

  7. Great explanation James. I recommend Target Date Funds to everyone that has them available in their 401(k) plan, or cousins 403(b), 457 and TSP. They are a great retirement savings vehicle for anyone that wants a hands-off approach, and like you mentioned, have very low expense ratios (typically).

  8. Thanks for explaining these funds. I also appreciated your arguments for the simple and smoother path to wealth, which I’m doing.

    I’m invested solely in VTSAX in taxable accounts. I do have a 6 month emergency fund in cash outside of that and I’m 28 years old. Why exactly should I buy bonds? I don’t honestly understand the reason for it, as it will increase taxable events for me and likely perform much, much lower than the stock market index. At my age, what makes sense to buy in addition to VTSAX?

    I like your recommendation of VGSLX and may considering buying some. What do you think about my buying those versus bonds? Also, what arguments are there for utilizing my employer’s simple IRA plan and a Roth IRA? I don’t have or contribute to either at the moment. My plan is to retire early (late 30′s/early 40′s) and I have a hard time accepting that I won’t be able to use the money until I’m 59 1/2.

    • jlcollinsnh says:

      Hi Kraig….

      Were I in your position and 28, VTSAX is the only fund I’d own, per The Simple Path. Provided you are mentally prepared for the wild ride.

      The only reason to own bonds, especially in this era of super low interest rates, is to smooth out the ride. It is more profitable over time to get mentally tough as per Part I in this series. Same applies to REITS, which I’d own before bonds at your age.

      If your employer offers a match, that makes their IRA plan a no brainer. Especially if your income is high enough to make the tax deduction worthwhile.

      Roth IRAs allow your money to grow tax free and, importantly, be withdrawn tax free when the time comes. That’s why I love them.

      If you plan to retire early, having all your money in IRAs doesn’t work. But then, your savings rate will/should be such that you’ll have plenty invested outside IRAs too. You don’t need access to it all at the same time. I’d do, and did, both.

      Plus, 59.5 will sneak up on you sooner than you know. Trust me on that. :)

      BTW, I’ll be linking to one of your posts in my next.

    • Mad Fientist says:

      Kraig, you are able to withdraw Roth IRA contributions at any time, tax and penalty free, since the money you contribute to a Roth IRA has already been taxed.

      For example, if you contribute $5,000 to your Roth IRA today, you could take out $5,000 from that account next week without paying anything in taxes or fees. Say, however, that you decide to leave the money in there for a year and the $5,000 earns $100 in dividends, you’d still be able to take $5,000 out of your Roth IRA tax and penalty free but you’d have to pay a penalty if you decided to take out the additional $100 that was earned in the account.

      I am also planning on “retiring” in my 30’s but I still max out my Roth IRA every year because it provides a way to obtain additional tax-free growth. I simply maintain a spreadsheet that keeps track of how much I’ve contributed to the account so that I know how much I could withdraw before 59 1/2 (I hopefully won’t touch any of that money until standard retirement age but it’s nice to know that I can).

      So in your case, if you put $5,000 into your Roth IRA every year from now until you retire when you’re 38, you’ll have $50,000 worth of contributions in the account and $19,082 in earnings (assuming a 7% return). You could take that $50,000 out to use in early retirement and leave the $19,082 to grow tax free until you’re 59 1/2. Again assuming a 7% return, the $19,082 will have grown to over $79,000 by the time you eventually reach standard retirement age!

      • Mad Fientist and jlcollinsnh,

        Thanks for the great responses. jlcollinsnh, thanks for the recommendation to be 100% in VTSAX. That’s exactly what I was thinking and I love the idea of keeping in that simple.

        Mad Fientist, thanks for the advice on funding the tax advantage accounts due to the ability to pull out my contributions. I think I’m going to open and max out a Roth this year and likely contribute up to the limit on my employer Simple IRA plan.

        jlcollinsnh, I’m looking forward and honored that you will be referencing one of my posts in the near future.

        Kraig

  9. lise says:

    Thank you for these posts. I’ve got some way to go before retirement and a few obstacles, such as living in a country that would rather you didn’t save for retirement yourself: Norway. So my comment is a question, do you (or anyone reading) know how to invest in Vanguard from Norway (or indeed any European country)?

    • jlcollinsnh says:

      Hi Lise….

      Vanguard does have a presence in various countries around the world, including several in Europe. You can check them out here:

      https://global.vanguard.com/portal/site/home

      Denmark and Sweden are both included, but unfortunately I don’t see Norway.

      I am a bit surprised Vanguard doesn’t cover the EU as a whole, but that also wouldn’t help you folks in Norway.

      The good news is Vanguard, with its client centered focus, is expanding rapidly. Hopefully Norway is next!

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