Target Funds Miss the Bull's-Eye

06/08/2010 10:53 am EST

Focus: FUNDS

Daniel Wiener

Editor, The Independent Adviser for Vanguard Investors

Daniel Wiener, editor of the Independent Adviser for Vanguard Investors, says Vanguard’s life-cycle funds are pretty complicated and often don’t serve investors’ needs very well.

I'll say this for life-cycle investing: For something that was supposed to be a simple and fool-proof investment strategy, life-cycle funds like Vanguard's STAR LifeStrategy and Target Retirement funds sure turned out to be complicated and fraught with problems, not the least of which were huge, unexpected losses suffered during the last bear market, which was the first bear for most life-cycle funds and shareholders.

By my count, Vanguard offers 19 different life-cycle funds. Fully ten different Target Retirement funds (all but Target Retirement Income) are in the category of target maturity funds. Finally, there are the three Managed Payout funds with allocations that vary with the whims of the management committee that runs them.

All but one of Vanguard's retail life-cycle funds rely heavily on indexing for their underlying investments. The Managed Payout funds do venture a bit further afield with investments in commodities, for instance, but they are still index-based. The variety of allocations Vanguard has built almost defies logic. So, why?

The answer is that Vanguard has simply been following the money and "investor preferences." It turns out that investors in retirement plans such as 401(k)s have increasingly been sinking their money into targeted maturity funds rather than fixed allocation funds. People who don't want to think about their investments are really just putting it away and forgetting it.

This is lowest-common-denominator investing, and Vanguard loves it. For one thing, it's attractive to folks who just aren't interested in their investments. And once those investments are made, they stick. All fund companies like "sticky" assets.

Obviously, if you simply tell someone to pick the fund whose date most closely matches their expected year of retirement, you've made things ultra-simple. Vanguard hopes that, like the investors they're intended for, many corporate 401(k) plans will pick up the Target Retirement funds as options for employees and then forget about them. Maybe the simple approach is simply what corporate benefits managers are looking for.

What's missing, of course, is the ability for the investor to choose their allocation and the funds they will use to achieve that allocation. And, as I mentioned, until this last bear market there's been little to no discussion of risks.

Before the 2008 bear mauled the markets, I had calculated risks for all of Vanguard's funds based on the historical performance of the underlying portfolio components. It wasn't pretty, with many funds having the potential to lose almost 40% of their value.

Well, it got worse in the recent bear market. No wonder "set it and forget it" investors awoke with a start.

Investing in one of Vanguard's many "life-cycle" funds is nowhere near the same as investing in a well-tuned portfolio of individual Vanguard funds geared to your objectives and risk tolerance. It may feel like you're doing your money some good by investing in a life-cycle fund, but in fact you could be simply spinning your wheels.

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