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Why I Prefer Vanguard LifeStrategy Funds to Target Retirement Funds

A reader writes in, asking:

“I enjoyed the Bogleheads piece. [Editor’s note: He’s referring to this recent Money article by Penelope Wang.] I noticed that there was a recommendation for the Target Retirement Funds. I wonder if you’d run your preference for the LifeStrategies Growth Fund by me one more time?”

As a tool for investors in general, I prefer the LifeStrategy funds primarily due to their naming convention (i.e, the use of the names Growth, Moderate Growth, Conservative Growth, and Income rather than date-based names). When presented with a menu of LifeStrategy funds, an investor is forced to actually think about his/her risk tolerance in order to decide which fund is the best fit. In contrast, with the Target Retirement funds, there’s an easy alternative: just pick based on the date.

The problem here is that, while time to retirement is a factor that affects your risk tolerance, it is just one of several factors. And, in many cases, it isn’t even the most important factor.

For example, I know many Gen-Y investors who are chronically underemployed, yet who have nonetheless managed to scrape together some money to invest in a Roth IRA. Despite the fact that they’re a long way from retirement, they need to use conservative allocations in their IRAs, because there’s a significant chance that they’ll have to tap into the money in the not-so-distant future, due to income instability and small emergency funds.

On the other end of the spectrum, there are retirees whose day-to-day needs are completely satisfied via pensions and/or Social Security. Despite the fact that they’re already retired (i.e., time to retirement = zero), an aggressive allocation could be quite reasonable, should they desire to use one.

And even if investors are told to pick a target date fund based on the fund’s underlying allocation rather than the date in the fund’s name, there’s still going to be an anchoring effect involved. In other words, investors will probably not adjust as much as they should in order to account for their personal risk tolerance. For example, a conservative investor planning to retire in 2040 might be best served by the allocation of the 2015 fund. Yet because he’s been told that the 2040 fund is typical for somebody his age, he only adjusts slightly — by using the 2035 fund for instance, despite the fact that it’s still much too risky for his needs.

With regard to why I personally am using the LifeStrategy Growth Fund rather than a Target Retirement fund, the answer is that my wife and I don’t, as of right now, plan to shift our allocation toward bonds over time. Rather, as we near (and enter) retirement, we expect to simply put money into inflation-adjusted lifetime annuities (including Social Security) until we’ve reached the point where our basic needs are satisfied via very safe sources of lifetime income. With money that’s left over, the plan is to continue using a stock-oriented allocation.

All of that said, I’m still a big fan of Vanguard’s Target Retirement funds. I don’t like them quite as much as the LifeStrategy funds, but I still think they’re fantastic in that they can provide a diversified, hands-off portfolio at a very modest price.

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