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.