What are Vanguard ready made funds?
In the post KISS Investing we were introduced to Vanguard Target Date Retirement funds and Vanguard LifeStrategy funds. This post provides a bit more understanding of how these two funds work. Link:
Vanguard was founded in 1975 by the late John Bogle and is one of the biggest asset managers in the world. It is famous for low cost index funds which spread risk through diversification and keep management costs low to ensure that any returns over the decades are not gobbled up by a fund manager.
Vanguard Target Date Retirement funds
Target Date Retirement (TDR) funds provide the simplest of all possible paths. One fund, very simple, set and forget. TDR funds are ready-made portfolios that make investing for retirement easy. You simply choose a fund based on when you plan to retire and then let it run; buy just one fund and own it till your dying day.
There are eleven TDR funds ranging from retirement date 2015 to 2065; simply pick the year you plan to retire and that’s your fund. Other than adding as much cash as you can over the years and arranging for withdrawal payments when the time comes, there is nothing else you need ever do. Set up your monthly direct debit, turn your chair sideways, look out of the window and do nothing else until you retire and start spending!
The TDR fund is a fund of funds and offers a diversified global index asset allocation in a single product. It automatically rebalances the asset allocation and gradually dials down the Equities and dials up the Bonds as you age – lowering your risk exposure as retirement draws nearer.
The asset allocation ride looks like this:
Vanguard’s example starts at age 25 and ends with retirement at age 68. Allocation is 80% Equity and 20% Bonds for the first 18 years up until age 43. The portfolio gently de-risks until you are 50:50 by age 68. There’s a steep decline over the next seven years until 30% Equities and 70% Bonds.
The aim is to balance the need to grow wealth while taking steps to preserve retirement savings. At the start, they invest mostly in Equities, because although Equities are riskier, they offer higher potential returns. As you get closer to retirement they start switching out of higher-risk, higher-reward Equities and into more stable Bonds.
At a young age, with time on your side, you can ride out any ups and downs in the stock market. As you get closer to retirement, the gradual move into Bonds provides more stability but offers lower potential returns. The idea is that as you get closer to your goal, you will be more interested in preserving what you have with Bonds, rather than making big potential gains with Equities. After all, you do not want a stock market slump to reduce your savings just before you intend to start using them, as you won't have time to regain any losses.
For the UK version of the TDR Fund, the portfolio has been tweaked to be more UK biased as shown below:
Some investors believe the fund gets too conservative too soon. Others complain that they are too aggressive for too long. This is easy to adjust for: if you want a more conservative approach (greater percentage of bonds), choose a date before your actual retirement. If you want a more aggressive approach (greater percentage of stocks), just pick a later date.
Vanguard LifeStrategy Funds
If you want to manage your own risk level, the next simplest approach is to use Vanguard LifeStrategy Funds: One fund provides a fixed balance of Equity and Bonds to simply set and check occasionally to maintain the risk level you require.
There are five LifeStrategy funds in the range. At one end is LifeStrategy 100%, which is purely invested in Equities. LifeStrategy 20% at the other end is 20% allocated to Equities with the rest in Bonds. Your fund choice depends on your attitude to risk and need for growth.
Each LifeStrategy fund holds 6,000 to 20,000 Equities and Bonds from around the world (with a home bias). Vanguard monitors each LifeStrategy fund to make sure it sticks to the original balance of Equities and Bonds; this gives you the ability to decide which balance best fits your investment goal and attitude to risk. If you want to lower the volatility or risk as explained in Post 7 Investing 101, mix your risky Equities with Bonds.
The truth about investing is you can achieve life-changing results just by getting the basics right with a global low cost index fund and then staying with it for a long period of time to benefit from the magic of compound interest. Vanguard LifeStrategy fees are very low; a total annual cost of just 0.37% means that if you invest £10,000 you will pay Vanguard £37 each year.
The longer you hold the fund, the more time you have to ride the ups and downs of the stock market - which provides greater returns than Bonds. Your Pension is a long-term investment, so the opportunity is there to start with an Equity heavy portfolio (100% Equity) and reduce the risk as time goes by e.g. Pension later years - stop buying 100% and move to 60% or 40%...depending on your risk appetite.
Your ISA is for both the long-term and short-term so could be split into two portfolios:
Long-term (i.e. for retirement) = Equity heavy portion e.g. 100% Equity.
Short-term (i.e. for a special event) = Bond heavy portion e.g. 80% Bonds.
One Equity fund and one Bond fund so that you can withdraw from either depending on performance: if Equity is down, withdraw from Bonds and vice versa.
If you wish to avoid the Vanguard LifeStrategy UK bias, you can substitute LS100 with the Vanguard FTSE Global All Cap Index Fund which mirrors the real world with just 4% UK allocation rather than 25%. The Vanguard Global Bond Index Fund can provide the Bond allocation you require - this 2 fund approach is detailed in the post KISS Investing
In the next post, we’ll look at the best balance of Equity and Bonds.
Go check how your pension is allocated!