Vanguard made two big announcements this week.
First, their new Total International Bond Index Fund (which has been in the works since at least 2011) is expected to be open to investors by June of this year.
Second, they’re making two changes to their funds-of-funds:
- They’re adding the new international bond fund to each of the Target Retirement and LifeStrategy Funds (and to two of the three Managed Payout funds), and
- The Target Retirement funds that own TIPS (so, as of right now, Target Retirement Income, Target Retirement 2010, and Target Retirement 2015) will be switching from the intermediate-term TIPS fund to the short-term TIPS fund.
The Total International Bond fund is the topic for Monday, so we’ll be talking more about those changes shortly.
Regarding TIPS, it was purely by coincidence that we discussed the differences between the two TIPS funds this last Monday. If you read that article can probably guess my conclusion: The change is not a big deal. It should very slightly reduce the expected return and volatility of those three Target Retirement funds.
I say “very slightly” because the TIPS holdings for these funds range from just 5% to 20% of the portfolio. So this is a change, of a modest portion of the portfolio, from one type of inflation-protected Treasury bond to another type of inflation-protected Treasury bond.
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Hi. I'm Mike Piper, the author of this blog. I'm a CPA and the author of several personal finance books. The point of this blog is to show that investing doesn't have to be complicated. 
This is one of the reasons that I’m not entirely comfortable with Target Retirement offerings (and the like). You pick a fund because it suits you, but then they make changes in the future.
I’m not commenting on the changes outlined above in particular, but rather on the fact that they do make changes and sometimes these changes can be significant. For example, back in 2006 (old history, I know) they made their TR offerings with a 25+ year time horizon significantly more aggressive by moving a bunch of the bond allocation into stocks. Great timing, huh?
The point being, you run the risk of locking yourself into an investment that might fundamentally change in the future, and there could be significant tax consequences for you to change funds if you don’t like what they’ve done.
I think funds-of-funds are already a poor choice for a taxable account, even if the management company never changes the allocation. But you’re right that that possibility makes it even worse.
As somebody who holds a fund-of-funds in retirement accounts though, I’m not super concerned. I think it’s definitely a good reason to keep an eye on your fund-of-funds (which, admittedly, many people don’t do), but not necessarily a reason not to use them.
Do you see any diversification benefit in adding international bonds?
Larry,
I’ll talk a bit more about this on Monday, but the short answer is that Vanguard’s research (which I have no reason to doubt) shows a very slight diversification benefit when adding (currency-hedged) international bonds to a portfolio of US bonds, and US and international stocks. But it’s hard to overemphasize the “very slight” words here.
You forgot to mention that Vanguard will also be dropping the Prime Money Market Fund from the Target Retirement Funds. Shouldn’t this increase expected returns?
Peter: Assuming that whatever it’s being replaced with has an expected return of greater than 0.01% nominal, then yes — that’s the current SEC yield of Prime. Of course, Prime is also perfectly stable in value (ignoring inflation, of course) so removing it will add risk (no free lunch).
Yes, what Michael said.
The reason I didn’t mention it was simply that the change is so small. For the Target Retirement Income fund, the Prime fund is just 5% of assets. For the 2010 fund, it’s just 1.7%.
Interestingly, the announcement didn’t say what they’re replacing it with. Given that they didn’t state a specific replacement fund, my guess is that the previous Prime allocation will simply be split up proportionately among the rest of the funds in the portfolio.