This week, we take a deep dive into Vanguard‘s Target Retirement funds. In a nutshell, they are cheap, diversified and automated. What’s not to like?
In theory investing is easy. Pick the right strategy and add money whenever you’ve got some free. Easy right?
Well, not quite. To begin with, picking the right strategy isn’t as simple as it should be. When there’s money to be made, things tend to get complicated. In the main, this tends to be caused by people who want to charge you money for something. More often than not, something that you don’t need.
Not a day goes by when there’s not some reason to invest in some special fund or another. Perhaps because it has done well recently or it has the current flavour of the month money manager.
And the thing is, the more you get into investing the more you realise all you need is some global stocks and a few bonds.
These days you can put a strong investment portfolio together simply via a couple of well chosen Exchange Traded Funds (ETFs). One for your bonds and one for your stocks.
The only decision you need to make is how to split between these two. There are lots of different options (which I’ve talked about here). However, my personal favourite is the 4% rule, meaning you have 4% in stocks for every year you intend to invest.
So investing for two years would mean having 8% of your money in stocks and 92% in bonds. Whereas investing for 10 years would mean having 40% of your money in stocks and 60% in bonds.
Of course there could be a slight issue with this in that your strategy is continually altering as time goes on. Say you are investing for two years, you’d have 8% of your money in stocks for the first year but only 4% in stocks for the second year.
Changes with your investment portfolio require time and effort. This is because you will need to sell some stocks and buy some bonds to get everything back in the correct proportions. And though this sounds like an easy thing to do, unfortunately, evidence from MorningStar suggests this isn’t the case.
It all comes down to psychology. Investors get scared and sell stocks when they really shouldn’t. And they get greedy and buy stocks when it would be far better not to. This buying and selling lead by fear and greed causes the average investor to under-perform the actual funds they invest in by 2%.
I know 2% doesn’t sound like a lot, but over time it could be. On £100,000 over 20 years it would be £50,000. One of the biggest investment firms in the world, Fidelity, did a study that found their best performing investors had either forgotten about their accounts or were dead! In short, the guys that didn’t fiddle with their portfolios did best.
And this is where Vanguard Target Retirement comes in. By combining stocks and bonds in one fund and automatically rebalancing, these funds make it easier for investors to………Well, just leave them alone.
And as we’ve already discussed just leaving your investments alone tends to lead to better returns. It also leads to less work for you.
In fact, with Vanguard Target Retirement funds, all you need to do is add money when you have it. Simple! And I’m sure it goes without saying that setting automated payments from your bank would make it even simpler.
You spend an hour or so setting up your account at the beginning and you are off. Just about everything else is automated for you for the duration of your investment period. After that the only time you need to bother with your account would be once you needed your money. For most people that’s going to be when it comes to start enjoying your retirement.
These funds don’t follow my 4% rule, but they do something similar. They keep 80% invested in stocks until you are about 44 years old. This steadily declines to somewhere near 50% at age 65. Then there’s a more dramatic decline to 30% at age 75. This proportion is then maintained indefinitely.
Though this sounds a little complicated, the good news is Vanguard Target Retirement funds make these adjustments. You hardly have to do a thing! Not only this, but they are constantly rebalancing what stocks and bonds you are invested in too.
You are effectively invested in a highly diversified portfolio of different assets across different geographies that is constantly being adjusted for you and you don’t have to lift a finger.
The only downside as far as I can see, is the proportion of the fund allocated to UK securities. For example, 25% of all the stocks are UK companies leaving 75% invested internationally. Of course some investors may be thinking that’s not enough. But the reality is, there’s a strong argument that it is too much. Let me explain.
I’ve written more about why investing globally makes sense here. However, to cut a long story short, a typical global index fund would only have about 5% allocated to UK stocks. Having any more than that allocated to UK stocks is essentially making a bet that the UK will outperform in the future. And by the way, that’s a big call.
Global index funds tend to be market cap weighted. This means they represent what the market thinks about everything from individual stocks, to entire countries. The market doesn’t often get things wrong. The fact that it is predominantly made up of humungous financial institutions makes sure of that. In short, you are better going with the market. In fact, there’s plenty of evidence out there that says going with the market will put you in the top percentile of investors. (Check out the latest SPIVA results if you don’t believe me).
That said, this is a small gripe and it certainly wouldn’t stop me investing in one of these funds. Unfortunately expatriates like me can’t get access to these funds yet. Instead, we are left with the slightly more complex two fund approach. (I’ve written about how expats can invest in Vanguard here).
For everybody else, Vanguard Target Retirement options would be a great set it and forget it option. Essentially, you get an advanced investment portfolio without any work on your part. Not to mention, the fact that the price is super competitive. The fund fees are just 0.24% per year. Added to Vanguard account fees (0.15%) and transactions fees (about 10%), you end up paying around 0.5% per year.So £100 on a £20,000 investment for example.
Disclaimer: Investing involves risk of loss
*Some official words from DEGIRO regarding the situation post Brexit are repeated below:
Deemed authorised and regulated by the Financial Conduct Authority. The nature and extent of consumer protections may differ from those for firms based in the UK. Details of the Temporary Permissions Regime, which allows EEA-based firms to operate in the UK for a limited period while seeking full authorisation, are available on the Financial Conduct Authority’s website.