Up until about a year ago, we relied primarily on Vanguard’s Target Retirement funds for our long-term investments. For those that aren’t familiar with them, these funds (and others such as the Fidelity Freedom funds and TIAA-CREF Lifecycle funds) are designed to provide an “appropriate” asset allocation based on the date at which you expect to need access to your money.
Not surprisingly, the more time that you have, the more aggressively these funds invest. Over time, however, they’re designed to automatically move to a more conservative allocation. Thus, they’re a very convenient “set and forget” solution. That being said, they’re not for everyone.
Why we abandoned target date mutual funds
As I alluded to above, we ultimately moved away from target date funds in order to gain more control over our money. We now hold a mix of low-cost index funds at our own, self-determined “ideal” allocation. Here were my four biggest concerns that caused us to move away from target date funds:
- Inappropriate allocation. The main reason that we moved away from Vanguard’s Target Retirement funds was that they were too aggressive for our taste. For example, the Target Retirement 2035 fund had an allocation of 90% equities and just 10% in bonds. While we could’ve simply selected another, less distant year, we didn’t like the way these less aggressive options re-adjusted down the line. Which brings us to…
- Inappropriate “glide path.” The glide path refers to the way in which the overall allocation changes over time. In our case, if we had chosen a less distant target date, we would’ve gotten an appropriate allocation in the near term, but it would’ve become too conservative too quickly. In short, we’re looking for a flatter curve — i.e., a bit less aggressive up front, but with a slower transition toward an ultra-conservative mix on the back end. After looking around, we simply couldn’t find the right balance.
- No control over what goes where. I’ve written in the past about optimizing the location of your assets to maximize tax efficiency. In general terms, you want tax-inefficient investments (such as bonds) in a tax-sheltered account, and so on. But with target date funds, you lose the ability to do this. Indeed, each and every share is composed of both stocks and bonds, meaning that you can’t separate your holdings by account type.
- Continuous rebalancing. While the auto-balancing offered by these funds is convenient, the fact that they’re continuously rebalanced means that you never really “let your winners run.” While rebalancing recommendations vary, the conventional wisdom is that you should do it periodically (say every six or twelve months) or when your allocation is more than a certain percentage out of whack. Doing this forces you to sell high and buy low.
Defining proper allocation
Another interesting point when it comes to target date funds is that the definition of an “appropriate” allocation not only varies across fund families, but can also change on a whim. In fact, back in 2006, Vanguard decided to reduce the bond exposure in all of their funds with a 25+ year time horizon from as high as 24% to just 10%.
While I’m not sure of Vanguard’s reasoning when it came to making these changes, I’d be willing to bet that it had at least a little to do with performance chasing. After all, most investors look at past performance when comparing funds, so taking a more conservative stance in a rising market is a great way to lose business. Of course, the past year has shown us the price of being overly-aggressive.