Another Approach To Retirement Planning: Balancing A Retirement Target Fund Myself

Regular readers of The Simple Dollar are aware that I’m going through the process of starting my Roth IRA. For those unaware, so far I’ve decided to start a Roth IRA this year, found a company (Vanguard) that I’m comfortable with as a manager, developed a detailed plan for making it happen this year, and looked at some of the Target Retirement funds that Vanguard has to offer.

Over the last week, however, I’ve been strongly considering the possibility of managing the funds of a Target Retirement fund myself within my Roth IRA. For example, if we look at the Vanguard Target 2045 fund, we see that it’s currently made up of five separate funds: four stock funds (Total Stock Market (about 72% of total holdings), European Stock (10.5%), Pacific Stock (5.0%), and Emerging Markets (2.7%)) and a single bond fund (Total Bond Market, about 9.9%). Since Vanguard provides this information on their website, wouldn’t it make sense to approximate their holdings and just balance the whole thing myself, saving myself another layer in fees?

There is one little problem: each of these funds has a $3,000 minimum, which means that in order to hold the Emerging Markets fund at that exact proportion of the portfolio, I have to invest $110,000 or so in the Roth IRA. At a rate of $4,000 a year, that’s basically saving until retirement just to match their balancing.

So I took their numbers and rebalanced it a bit. Instead of their proportions, my retirement fund would be roughly 50% Total Stock Market, 20% European Stock, 10% Pacific Stock, 10% Emerging Markets, and 10% Bond Market. Given that I would put the minimum $3,000 into the 10% funds, I would need to have $30,000 to build this portfolio, or seven and a half years of Roth IRA contributions.

So, here’s my plan for investment. In the next seven and a half years, I’ll do the following:

Year 1: Put my entire $4,000 allotment into the Total Stock Market Fund. I still have $11,000 to go for that one in the next six and a half years.

Year 2: Put $3,000 in the European Stock Fund (leaving another $3,000 to go over the rest of the period) and another $1,000 into the Total Stock Market Fund (leaving $10,000 to go).

Year 3: Put $3,000 in the Pacific Stock Fund (fully funding it until I’ve reached the “balancing” stage) and $500 each in the European Fund ($2,500 to go) and the Total Stock Market Fund (another $9,500 to go).

Year 4: Put $3,000 in the Emerging Markets Fund (fully funding it until I’ve reached the “balancing” stage) and $500 each in the European Fund ($2,000 to go) and the Total Stock Market Fund (another $9,000 to go).

Year 5: Put $3,000 in the Total Stock Market Fund (leaving $6,000 to go) and $1,000 in the European Fund (leaving $1,000 to go).

Year 6: Put $3,000 in the Total Stock Market Fund (leaving $3,000 to go) and $1,000 in the European Fund (fully funding it until I’ve reached the “balancing” stage).

Year 7: Put $3,000 in the Bond Market Fund (fully funding it until I reach the balancing stage) and $1,000 in the Total Stock Market Fund (leaving $2,000 to go).

Year 8: Put the final $2,000 in the Total Stock Market Fund, and “balance” the rest.

Basically, the “balancing” phase means that I’ll match contributions into each fund to make my amounts in each fund best match the current proportions of the Target Retirement 2045 fund. In essence, I would keep investing in the proportions I had set up (5:2:1:1:1, or slightly more into the smaller ones depending on minimum monthly contribution limits) and pretty heavily shift that contribution into bonds as I enter my 40s and 50s, effectively balancing my portfolio using my contributions.

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  1. Ravi says:

    Have you considered becoming ineligible to contribute to Roth in the coming years? I am kicking myself for not contributing to Roth and I only did the last few years. Now, I am over the IRS Limit and can’t contribute unless my income level drops at some point.

  2. My previous comment somehow didn’t make it.

    You wrote “wouldn’t it make sense to approximate their holdings and just balance the whole thing myself, saving myself another layer in fees?”

    The Target Retirement Funds do *not* have an extra layer of fees. The expense ratio on the Target Retirement Funds is a pass-through from the component funds. Investing directly in a Target Retirement Fund is a lot easier than trying to construct your own using its allocations.

  3. Bram says:

    You should know that the Target Retirement funds do not add an extra layer of fees to the underlying holdings. The term “average weighted expense ratio” from the fund info page is somewhat confusing. You should read response #1, last paragraph, of this link on the highly regarded Vanguard Diehards forum on Morningstar.com.

    If I were in your situation (and I once was) I would simply hold the TR2045 fund and not worry about having to rebalance or contribute to the right fund all the time or anything like that. I went through the same thought process at one point in time as you are going through now. Then I was taught that investing should be simple and I shouldn’t try complicate it. Set it and forget it and get on with life!

    -Bram

  4. Meaghan says:

    Good idea in theory, however…

    1) There is no ‘other layer in fees’ that you’re saving yourself. The Target Retirement expense ratios are simply the weighted expense ratios of all the funds they invest in. In fact, with Vanguard charging a $10 yearly fee for index funds with balances of less than $10,000(?), you’d be giving yourself more fees doing it that way.

    2) You lose diversification, waiting years to invest in important asset classes such as emerging markets and bonds.

    3) Since you’re investing in a Roth IRA, even if you wanted to eventually have exactly the same proportion of funds as the TR fund, you could easily just contribute to the TR fund until you have $30,000, then diversify the way you want to. It’s incredibly easy to exchange funds at Vanguard, no costs whatsoever, and it’s not a taxable event since you’re in a Roth IRA.

    I’m not saying there’s no value to investing in funds other than the TR fund. If your target allocation is different than theirs, if you have several accounts and only want to use your Roth for one asset class, if you qualify for admiral shares in several of the funds that offer them, sure. But for many people (including myself), they’re the superior choice, at least until you have enough money in your accounts to diversify the way you want.

  5. Drew says:

    I had a lot of things that I wanted to say when I saw this post, and Meaghan pretty much said it all. But the target fund now and then use the money later to redistribute it if you don’t like the way their doing it.

    The nice part about the target fund though is you don’t HAVE to do all that work. Right now at least, it’s exactly what you want, at an extremely low cost (the fees are very reasonable), and requires no effort on your part. Plus, until you have the $30,000 built up, you’ll already be diversified.

    The most obvious thing that will begin to happen to the market in the coming years is for emerging and European markets to outperform the domestic market. The whole point of diversifying is that you need to be ready when that kind of shift comes: if all you’ve got to start with is the total market, you’re at a lot more risk than you realize, and you won’t be able to catch up easily.

  6. Debbie says:

    Wow, the above advice is better than mine, but here goes anyway.

    It looks like your plan is to fund the different sectors in order of importance. For at least those sectors of equal importance (the three to which you want to contribute 10%), you could determine the order by which is doing worst at the time.

    Find a tool that graphs the prices on these over many years on the same graph (I use Yahoo). These graphs have all the lines starting at the same point so you can see how the increases and drops would compare if you had spent the same money on each of them. So my advice is to fund whichever one is doing worst right now, because that means you’re getting a better price.

  7. phil says:

    Doesn’t Vanguard have equivilent ETFs for all of those funds? Why not buy ETF shares in a sharebuilder account instead? ($4/trade, or if you pay $12 for the month you can get six trades in that month free).

  8. MidnightUT says:

    I have to thank everyone above me for the great advice. I’m going to be starting my Vanguard Roth IRA in the next month or so for the 2006 year, and I’ve been on the fence as to whether I wanted to use a target fund or “do it myself”. I’m really leaning towards the target fund, as it seems like the best of both worlds. As I’m getting started I want the ability to diversify without the hassle, but after a few years I’ll still have the flexibility to reshuffle a bit.

  9. Trent Trent says:

    I agree. I am still thinking about balancing my own, but the comments on The Simple Dollar day after day really, really impress me.

    Thanks, guys!

  10. Philip says:

    To reiterate what several posters mentioned, while target retirement funds are “funds of funds”, only the top-level management fees and expense ratios apply.

    With the Vanguard Target Retirement 2045, for example, the expense ratio is only 0.19%, with no other fees (though they have a $20 annual account fee below $10,000 if you don’t use their website or electronic statements/notices).

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