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How Vanguard's Target-Date Series Has Changed--Or Not

Christine Benz

Note: This video is one of several interviews that Morningstar director of personal finance Christine Benz had with Vanguard officials at this year's Bogleheads event. See all of the interviews here.

Christine Benz: I want to talk about changes to Vanguard's Target Retirement Series. Since the original launch I can think of couple of developments, the inclusion of foreign bonds, for example. Can you talk about some of the major asset allocation changes that have occurred in the Target Retirement funds?

John Croke: We've been around for 15 years. I always like to remind people, it's a teenager, we're still kind of relatively early in our journey relative to more established investment products. We've made one change to our glide path, that mix between stocks and bonds throughout the life cycle. That was back in 2006. There were couple, I'd call it more behavioral and kind of noninvestment drivers of that decision when you think about what was going on with the rate of extinction of private employer DB (defined benefit) plans as a source of income for traditional pension plans for retirees. You think about the good news story of our own mortality and longer life expectancy and the need to have our assets work longer and deeper into retirement.

I'd say another piece is the observation back then, still holds true to a certain degree that when you think about the consumption basket of retiree, what do they need to spend their assets down to maintain their lifestyle, the rate of inflation around healthcare cost, particularly retiree healthcare cost, was moving at a higher trajectory than originally anticipated. Those three drivers caused us to essentially move up, call it 10%, across our glide path to what investors will see in our product today. 

We've had that glide path for now 12 years. It has been tested and survived the global financial crisis. The other changes as you point to that have been broader thematic direction with our target date franchise is moving away from home country bias, taking on a more globally diversified posture. We think it's an important story and a important way to build a portfolio not just for equities or stocks. I think that's something that has kind of accepted as a best practice in investing.

We believe it's a story that's just as compelling and just as relevant in fixed income, and we allocate 30% of our traditional bond exposure to markets outside of the U.S. We think that's particularly important for an older investor that's near the bottom of our glide path, that's going to have most of their capital riding on, in the absence of any international bonds, one bond market, one economy, one inflation environment, one central bank. We see a lot of logic to opening that up to other economies, other central banks, other yield curves, other issuers. It's something that's been a nice element of designing this product to smooth out the ride as much as possible. Maximize the diversification at your disposal, because we want to make sure that people that are investing in these strategies, stay committed, stay invested to this thoughtful, professionally managed rebalancing allocation throughout their lifetime.

Benz: I wanted to touch on that issue of making sure that people stay in their seats, but before we get to that, in terms of the foreign bond exposure, that's all hedged into the dollar. People aren't picking up on lot of that currency-related volatility.

Croke: That is true. We hedge the foreign bonds and our target-date funds, because in the absence of a currency hedge or converting it back to U.S. dollar exposure, what you have in an unhedged foreign bond portfolio is mostly currency risk and a little bit of interest-rate and credit risk. We really want that interest-rate and credit risk. We want to introduce that into the portfolio. We are not interested in adding currency risk into our portfolio. We do make that hedging decision at that building block level.

Benz: Right. One thing I want to ask about is that some other firms have introduced a gradation of risk level. For a given age band, there might be conservative, moderate, and aggressive. Vanguard has not gone that route and I am wondering if you can share what has influenced the decision to just have the single product geared toward a given age band.

Croke: That's right. Our product is designed to meet the needs of most investors, and we are looking at average and median wealth, income, savings, and risk tolerance. Right now, there are some challenges, and it has been this case for a while, that investors are challenged to self-identify their risk tolerance.

Often you have to fill out a questionnaire that can feel little bit wonky or little removed. Sometimes depending on when you take that questionnaire and what else you are experiencing in your life can impact what that questionnaire might point you to. Then often if you are given the choice of a high, medium, and low, which most people do who don't feel like they confidently know their own risk tolerance, you take the middle. Given the fact that in a target-date fund, you are solving an investment problem for an investor where you know one thing and one thing only about them: when they approximately expect to retire.

Benz: Right.

Croke: Let's put them in a reasonable asset allocation that is going to be appropriate and suitable for the vast majority of investors. If you are an investor who can self-identify or take a questionnaire, and feel like, hey, I have a different risk tolerance, you can go look in the balanced or static allocation products and say, hey, you know what, I might be older but I have a financial situation and an ability to take risk where I should probably have more of my assets in the equity market than kind of "the average" investor and target-date fund, go ahead and make that choice and align your asset allocation to your own unique circumstances.