Part one and part two of “Diversifying Your Portfolio” cover the importance having a strong asset mix. In this article we’re going to cover target funds. Target funds have been growing quickly in popularity because they are designed to ease the pain of ongoing rebalancing for proper diversification. Let’s take a took look at Vanguard’s Target Retirement 2055 (VFFVX) fund to see how it’s structured.

Target Retirement 2055 Breakdown

The Target Retirement 2055 is a fund that invests in four other funds. Below is a breakdown of the fund name and their corresponding percentages.

Fund Percentage
Vanguard Total Stock Market Index Fund Investor Shares 54.1%
Vanguard Total International Stock Index Fund Investor Shares 35.8%
Vanguard Total Bond Market II Index Fund Investor Shares 7.1%
Vanguard Total International Bond Index Fund Investor Shares 3.0%

Notice how stocks take around 90% of the portfolio and bonds take 10% if we tally up the percentages. We can estimate a portfolios target demographic by calculating backwards with the 120-age rule. For example, a portfolio with 90% stocks would be fitting for a 30 year old because relatively younger investors can handle more risk. If a 30 year old did follow through and retire at 2055 they would would be around 65 years old, an age where many people begin to consider retirement. Target funds automatically rebalance the stock to bond percentage as time progresses.

Looking from a purely domestic vs international standpoint, domestic holdings take up 60% of the portfolio and international holdings take the other 40%. While the ratio of domestic to international stocks is still up for contention, common opinion rarely recommends more international stocks than domestic.

Target Retirement 2020 Breakdown

Let’s take a look at a retirement fund with a closer target retirement date. The Vanguard Target Retirement 2020 fund is composed of 60% stocks with the rest allocated to bonds. Using the 120-age rule, we recognize this portfolio anticipates retirement either in the 60’s or very soon. (VTWNX)

Fund Percentage
Vanguard Total Stock Market Index Fund Investor Shares 34.5%
Vanguard Total Bond Market II Index Fund Investor Shares 28.3%
Vanguard Total International Stock Index Fund Investor Shares 22.8%
Vanguard Total International Bond Index Fund Investor Shares 12.0%
Vanguard Short-Term Inflation-Protected Securities Index Fund Investor Shares 2.4%

You can even consider a 50% bond allocation or more if retirement is on the horizon. Senior investors have a lower risk tolerance and face serious financial roadblocks if their assets take a hit. Stocks which are more volatile have a higher chance of losing their value and blowing away any potential savings. Bonds are a safer investment with despite having lower returns.

Analyzing this portfolio from a geographic standpoint, 65% of is domestic, and 35% is international. It’s interesting that there’s a lower percentage of international holdings relative to domestic. It’s clear Vanguard believes domestic holdings are safer, maybe because of home bias or strength of the U.S. dollar.

There’s a third category introduced in this fund called “Short-Term Inflation-Protected Securities” (VTIPX). Essentially these shares value changes according to interest rates and inflation. Since it’s designed to generate returns closely correlated with changes in inflation, it doesn’t generate significant returns but is a safe way to hedge against unexpected inflation (inflationary surprises). This is a great way to maintain value in your investments.

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