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VTWNX: This Is A Great Option For The Investor Nearing Retirement

Summary The Vanguard Target Retirement 2020 Fund has a simple construction and a low expense ratio. Despite being a very simple portfolio, they have covered exposure to most of the important asset classes to reach the efficient frontier. I would like a very slight modification to increase the allocation to higher credit quality bonds at the expense of lower quality bonds. This is quite simply one of the best constructed portfolios I’ve seen for a worker nearing retirement. Lately I have been doing some research on target date retirement funds. Despite the concept of a target date retirement fund being fairly simple, the investment options appear to vary quite dramatically in quality. Some of the funds have dramatically more complex holdings consisting with a high volume of various funds while others use only a few funds and yet achieve excellent diversification. My goal is help investors recognize which funds are the most useful tools for planning for retirement. In this article I’m focusing on the Vanguard Target Retirement 2020 Fund Inv (MUTF: VTWNX ). What do funds like VTWNX do? They establish a portfolio based on a hypothetical start to retirement period. The portfolios are generally going to be designed under Modern Portfolio Theory so the goal is to maximize the expected return relative to the amount of risk the portfolio takes on. As investors are approaching retirement it is assumed that their risk tolerance will be decreasing and thus the holdings of the fund should become more conservative over time. That won’t be the case for every investor, but it is a reasonable starting place for creating a retirement option when each investor cannot be surveyed about their own unique risk tolerances. Therefore, the holdings of VTWNX should be more aggressive now than they would be 3 years from now, but at all points we would expect the fund to be more conservative than a fund designed for investors that are expected to retire 5 years later. What Must Investors Know? The most important things to know about the funds are the expenses and either the individual holdings or the volatility of the portfolio as a whole. Regardless of the planned retirement date, high expense ratios are a problem. Depending on the individual, they may wish to modify their portfolio to be more or less aggressive than the holdings of VTWNX. Expense Ratio The expense ratio of Vanguard Target Retirement 2020 Fund Inv is .16%. That is higher than some of the underlying funds, but overall this is a very reasonable expense ratio for a fund that is creating an exceptionally efficient portfolio for investors and rebalancing it over time to reflect a reduced risk tolerance as investors get closer to retirement. In short, this is a very solid value for investors that don’t want to be constantly actively management their portfolio. This is the kind of portfolio I would want my wife to use if I died prematurely. That is a ringing endorsement of Vanguard’s high quality target date funds. Holdings / Composition The following chart demonstrates the holdings of the Vanguard Target Retirement 2020 Fund: This is a fairly simple portfolio. Only five total tickers are included so the fund can gradually be shifted to more conservative allocations by making small decreases in equity weightings and increases in bond weightings. The funds included are the kind of funds you would expect from Vanguard. The top 4 which carry almost all of the value are extremely diversified funds. The Vanguard Total Stock Market Index Fund is also available as an ETF under the ticker VTI . I have a significant position in VTI because it carries an extremely low expense ratio and offers excellent diversification across the U.S. economy. Volatility An investor may choose to use VTWNX in an employer sponsored account (if their employer has it on the approved list) while creating their own portfolio in separate accounts. Since I can’t predict what investors will choose to combine with the fund, I analyze it as being an entire portfolio. Since the fund includes domestic and international exposure to both equity and bonds, that seems like a fair way to analyze it. (click to enlarge) When we look at the volatility on VTWNX, it is dramatically lower than the volatility on SPY. That shouldn’t be surprising since the portfolio has some large bond positions. Over the last five years it has significantly underperformed SPY, but that should be expected given the much lower beta and volatility of the fund. Investors should expect this fund to retain dramatically more value in a bear market and to fall behind in a prolonged bull market. Opinions I find this to be a very solid fund, but if I could make two adjustments it would be to slightly increase the amount of domestic equity at the expense of international equity and to increase the percentage of long term government debt by adding a small position in the Vanguard Long-Term Government Bond Index Fund (MUTF: VLGSX ). The long term government bonds have a negative correlation to equity markets and a high level of volatility. Due to the strong negative correlation they make the resulting portfolio less volatile than it would be without them. The ideal allocation would be fairly small, but I would prefer to a small inclusion of that (say 5%, maybe as high as 10%) at the cost of total bond index funds that will hold more corporate debt. Corporate debt can be a great investment, but because it is has more credit sensitivity the diversification benefits are weaker. This inclusion would be expected to drop the annualized volatility a little further. Conclusion VTWNX is a great mutual fund for investors looking for a simple “set it and forget it” option for their employer sponsored retirement accounts. It is ideally designed for investors planning to retire around 2020, but can also be used by younger employees with lower risk tolerances or older workers with higher risk tolerances. Disclosure: I am/we are long VTI. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

Don’t Ride The Roller Coaster, Bet On It

With global markets (esp. EM) stumbling, the upcoming FOMC meeting, political instability worldwide, and weak US domestic data, it may be time to bet on an increase in volatility. September through December are going to be some of the most volatile months in the year. Several options for investors: ETFs/ETNs that track volatility, such as TVIX, VXX, UVXY, derivative strategies, or going bearish/long-term on stocks. What a summer it’s been and September is only half-way over. Just overnight (as of Sept. 14th, 2015), Asian markets dipped again on poor economic data, with the mainland Shanghai Composite (SHCOMP) ending on -2.67% (at one point, nearly falling under 3k) and the Nikkei Index falling under 18k at -1.63%. Unfortunately, for international investors, this is not news . With the stock market crash that started in June and the subsequent desperate attempts by the Chinese authorities to prevent the crisis from getting any worse, everyone can at least agree on one thing: the ‘Asian century’ is faltering (for the brief three decades that it lasted) and the annual 8% GDP growth figures are a thing of the past. And considering China’s is a pseudo-market system run by an aging regime that grew up out of the throes of Mao’s Great Leap Forward and Cultural Revolution, recent events should come as a surprise to no one. From the real estate sector to the financials sector, China has been one giant bubble bound to burst. Below is the SHCOMP 1yr with Jean-Paul Rodrigue’s ‘phases of a bubble’ superimposed. (Source: Bloomberg Business) As to be expected, capital investment has been pouring out of China as illustrated below. And China’s isn’t the only market international investors need to be worried about. All of the emerging markets, especially the BRICS, are going to be very volatile. Between Brazil’s immense debt and failing presidency or Russia’s falling ruble and dependence on oil , emerging markets are going to be in quite a lot of pain in the coming months, especially since central banks are running out of options as most have already exhausted their QE (quantitative easing) measures. (Source: JPMorgan) (Source: Reuters & NASDAQ) Speaking of central banks, on September 16th-17th, the Feds will finally meet, in what was probably one of the anticipated and over-analyzed FOMC meetings in recent times, to discuss the results of their votes on a Fed rate hike. As grossly aggrandized as the possibility of a rate hike has been, it is an important element to consider, especially since EM countries gobbled up so much dollar-denominated debt back when it was cheap. Not only that, but the private-sector credit to GDP gaps in EM countries is growing fast; China’s alone is off 25.4% from its long-term trend, the highest of any major country, with Turkey and Brazil following close behind with 16.6% and 15.7%, respectively, far above the recommended ratio of less than 10%. A rate hike, which the CME Group predicts is a 75% probability for the upcoming meeting, is going to add to the enormous strain that the financial sectors of these countries will face. All of these factors piling up seem to spell doom-and-gloom for the rest of the world, but what of the U.S.? Well, to the excitement of the Fed, employment data, which was a serious concern during the 2008 financial crisis, is looking more and more positive month after month. As of August, the official unemployment rate fell to 5.1%, with some officials celebrating the return to ‘full unemployment’ levels . However, despite all the jubilation, productivity and actual GDP growth is still lagging way behind. Macroeconomic expert Chris Varvares estimates that “capital-equipment, software and buildings-per worker has grown just 0.3% a year so far this decade, by far the worst in at least 40 years.” Thus, real wages are also stagnant, as the yearly change rate is still hovering around 0-2% . With less cash to spend and winter months approaching, American consumers are not going to be rushing to get in line for Wal-Mart’s Black Friday sales, they’re going to be running to the banks to deposit and save. Great news for the banks, but bad news for consumption which drives the American economy. So, with the general consensus being that emerging markets will suffer greatly in the short-term at least, and that American consumer confidence and demand will slow as well, what does that mean for the average investor? Volatility. To determine volatility is to simply measure the size of changes in a security’s value over time, e.g. a higher volatility means larger fluctuations in a stock’s price in a short timespan. Volatility means different things to different people, that is, central bankers, for example, work to keep volatility at a minimum as part of their Dual Mandate to keep the prices of goods and services stable. However, speculators willing to take the risks involved can profit greatly from volatility…in the same way someone betting at the horse races can profit greatly betting on a lame horse, if you have the magic of foresight and/or are very lucky. But in all seriousness, certain investors can benefit in taking a smart position in indices which track volatility. (Source: Bank of International Settlements) (Source: Yahoo Finance) One such index tracker is the VelocityShares Daily 2x VIX Short-Term ETN (NASDAQ: TVIX ) which tracks two times the daily performance of the S&P’s 500 VIX Short-Term Futures Index. The iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ) and the ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA: UVXY ) are more bearish options with lesser expense ratios (0.89% and 0.95% v.s. TVIX’s 1.65%) and there are even more options, such as inverse VIX ETFs (which are essentially the opposite, i.e. betting on stability). Now , before you get your contrarian pitchforks out, there are some points that I will concede. I think Dan Moskowitz of Investopedia puts it best – “the only way to win playing TVIX is by having impeccable timing.” Going long TVIX is a sure-fire way to lose money as common sense dictates high volatility is not a permanent condition. Even further, on the contrarian side of things, TVIX has depreciated 99.97% since its 2010 debut, 77.92% over the past year! Clearly, it is a very risky game to play, yes (but so is the lottery and that’s a multi-billion dollar industry). However , the timing is perfect now. With all the recent domestic political turmoil across the world, emerging markets crashing, and the Fed signaling a tightening of monetary policy, I cannot see, save for a miracle from the Feds, the markets getting by unscathed without a few twists and turns. And speculators would seem to agree with this. According to the CTFC (Commodity Futures Trading Commission), as of Sept. 1st, speculators achieved an all-time record of net long VIX futures contracts, with 32,239 contracts added, double the previous record set in early February and the largest ever bet on a rise in the VIX. This is very significant; even the contrarians who would immediately disregard it and go bullish on stocks in spite have to admit that. (Source: J. Lyons Fund Management Inc.) For the average investor out there (such as myself) staying long on stocks and bonds, sticking to ETFs, or cashing out may be some of the best options available to avoid getting strung along for the ride as the markets reel and spiral. But for you aspiring speculators, hedge fund managers, or simple millionaires, this might be a very profitable time to be betting on increased volatility. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.