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VTHRX: A Great Mutual Fund For The Investor Nearing Retirement

Summary The Vanguard Target Retirement 2030 Fund has a simple construction and a low expense ratio. Despite being a very simple portfolio, they have covered exposure to most of the important asset classes to reach the efficient frontier. This is quite simply one of the best constructed portfolios I’ve seen for a worker nearing retirement. Lately I have been doing some research on target date retirement funds. Despite the concept of a target date retirement fund being fairly simple, the investment options appear to vary quite dramatically in quality. Some of the funds have dramatically more complex holdings consisting with a high volume of various funds while others use only a few funds and yet achieve excellent diversification. My goal is help investors recognize which funds are the most useful tools for planning for retirement. In this article I’m focusing on the Vanguard Target Retirement 2030 Fund Inv (MUTF: VTHRX ). What do funds like VTHRX do? They establish a portfolio based on a hypothetical start to retirement period. The portfolios are generally going to be designed under Modern Portfolio Theory so the goal is to maximize the expected return relative to the amount of risk the portfolio takes on. As investors are approaching retirement it is assumed that their risk tolerance will be decreasing and thus the holdings of the fund should become more conservative over time. That won’t be the case for every investor, but it is a reasonable starting place for creating a retirement option when each investor cannot be surveyed about their own unique risk tolerances. Therefore, the holdings of VTHRX should be more aggressive now than they would be 3 years from now, but at all points we would expect the fund to be more conservative than a fund designed for investors that are expected to retire 5 years later. What Must Investors Know? The most important things to know about the funds are the expenses and either the individual holdings or the volatility of the portfolio as a whole. Regardless of the planned retirement date, high expense ratios are a problem. Depending on the individual, they may wish to modify their portfolio to be more or less aggressive than the holdings of VTHRX. Expense Ratio The expense ratio of Vanguard Target Retirement 2030 Fund is .17%. That is higher than some of the underlying funds, but overall this is a very reasonable expense ratio for a fund that is creating an exceptionally efficient portfolio for investors and rebalancing it over time to reflect a reduced risk tolerance as investors get closer to retirement. In short, this is a very solid value for investors that don’t want to be constantly actively management their portfolio. This is the kind of portfolio I would want my wife to use if I died prematurely. That is a ringing endorsement of Vanguard’s high quality target date funds. Composition The fund is running almost 75% stocks to about 25% bonds, but over time the portfolio shifts to sell off stocks and hold more bonds as Vanguard assumes that investors nearing retirement will have a reduced risk tolerance. This portfolio strategy is the embodiment of what financial advisors seek to do for clients. Unfortunately Vanguard does not know the unique circumstances of every client, but for a .17% expense ratio they are doing a great job. Holdings / Composition The following chart demonstrates the holdings of the Vanguard Target Retirement 2030 Fund: (click to enlarge) This is a fairly simple portfolio. Only four total funds are included so the fund can gradually be shifted to more conservative allocations by making small decreases in equity weightings and increases in bond weightings. The Vanguard Total Stock Market Index Fund is the largest holding at 45% of the portfolio and it is also available as an ETF. The ETF version is the Vanguard Total Stock Market ETF (NYSEARCA: VTI ). To be fair, Vanguard has a great reputation for running funds but not for coming up with creative names. I have a significant position in VTI because it carries an extremely low expense ratio and offers excellent diversification across the U.S. economy. Volatility An investor may choose to use VTHRX in an employer sponsored account (if their employer has it on the approved list) while creating their own portfolio in separate accounts. Since I can’t predict what investors will choose to combine with the fund, I analyze it as being an entire portfolio. Since the fund includes domestic and international exposure to both equity and bonds, that seems like a fair way to analyze it. (click to enlarge) When we look at the volatility on VTHRX, it is dramatically lower than the volatility on SPY. That shouldn’t be surprising since the portfolio has some very material bond positions. Investors should expect this fund to retain dramatically more value in a bear market and to fall behind in a prolonged bull market. Investors may recognize that the max drawdown for this fund was not that much weaker than the max drawdown for the market overall. That is strongly related to this portfolio being designed for people that will retire in about 15 years from now or 23 years from the crash of 2007. It would be unwise for Vanguard to become too conservative. While the fund has underperformed the S&P 500 by a notable margin, it is worth noting that part of that underperformance has been tied to international markets doing quite poorly relative to the S&P 500 over the last several years. Over the longer horizon I think it would be absurd to expect the domestic markets to continue beating the international markets so thoroughly. When it comes down to it, VTHRX is doing a very solid job of providing risk adjusted returns for the passive investor. Conclusion VTHRX is a great mutual fund for investors looking for a simple “set it and forget it” option for their employer sponsored retirement accounts. It is ideally designed for investors planning to retire around 2030, but can also be used by younger employees with lower risk tolerances or older workers with higher risk tolerances.

VEU: This Passive International ETF Sets A High Bar

Summary The ETF has an excellent expense ratio. Investors need to remember the importance of international diversification even as domestic equity as thoroughly outperformed during the latest bull market. The ETF is highly diversified through over 2500 individual holdings. The sector allocations are very similar to the benchmark and to the category average. Peers with similar allocations and higher expenses are facing a tough battle. The Vanguard FTSE All-World ex-US ETF (NYSEARCA: VEU ) is a very solid international ETF. During the recession several years ago it took a pretty harsh beating but the value that was lost has been recovered since. International funds generally have been thoroughly smashed by domestic equity since the recession, but investors would be wise to remember the importance of some international allocations. Expenses The expense ratio is a .14%. Vanguard regularly sets the bar for creating low fee investment vehicles for investors to gain solid diversification with low costs. Holdings I grabbed the following chart to demonstrate the weight of the top 10 holdings: While these companies are international, some do have some fairly material direct exposure to the United States. Toyota Motor Corp (NYSE: TM ) certainly has a substantial presence in the United States and despite the problems the company has seen they have plenty of room to grow. As an analyst, it is rare to turn off the finance side of my brain. When I was visiting the local dealership for Toyota, there were a few things that stood out. To be clear, I believe that Toyota makes an excellent product. I believe their manufacturing practices are excellent. However, I believe their customer service strategy has been a severe handicap. This is important to the future performance of Toyota Motors because their ability to bring customers in on the service side of the business is dependent upon having satisfied customers. I fall into their target demographics. I’m a huge fan of their product line and have no intent to own any other brand of car for at least the next couple of decades. I put together a much more complete assessment of the weaknesses and potential fixes for their customer service flaws. Sectors (click to enlarge) You may notice an interesting thing in the sector allocations. The bench mark weightings, VEU’s weightings, and the category average weightings are generally fairly tight for any sector. There are quite a few funds where Vanguard is sticking to an index in a way that peers are not and the result is a material difference in the allocation weights. The reason this is material is because VEU has such a low expense ratio relative to other international ETFs. If Vanguard is going toe to toe with another fund manager that offers very similar sector exposures and a much higher expense ratio, then VEU has a huge advantage. For the other ETF to win, the opposing fund manager will have to manage the portfolio to have significantly better performance within the same sectors by regularly delivering superior analysis of the individual companies in the sectors. Some investors believe that will regularly happen, I believe it is more likely to reflect sample sizes than incredible skill levels. When the allocations are going to be very similar, I believe the low cost leader has huge advantage and will win over the long term most of the time. Region This is a fairly steady allocation with emerging markets being weighted at 17.7% of the portfolio. Europe gets a fairly huge weighting, so I wouldn’t combine this ETF with other international ETFs that are going heavy on Europe. Instead, I would simply cross off the other ETF and look for one that created a better match for VEU. Who wants to give up a low expense ratio on a fund with over 2500 individual holdings? If you want diversification, this is it. It makes more sense to drop other competing allocations. If investors feel more aggressive, they may want to consider adding on to the emerging markets exposure here. For the investors that want to make their portfolio more conservative, they might stick to using VEU for their entire international equity position. On the other hand, if they still find that using this for 10% to 15% of the portfolio is too dangerous, they may want to simply reduce the allocation in favor of short duration high quality bonds. Conclusion This is a great international ETF. It offers investors thoroughly diversified exposure and extremely low expense ratios. Even for investors that choose not to use VEU, it is very hard to make an argument against including it in any discussion for “best of breed” status among international ETFs.

I Own SCHF And Plan To Buy More; Here Is My Reasoning

Summary My international allocation is currently underweight, but I expect stronger performance in international markets moving forward. The Federal Reserve is pursuing a policy of raising short term rates even though the United States has higher 10 year treasury rates than many developed countries. The top holdings in SCHF have materially lower interest rates than the United States. I expect the expansionary policies to result in stronger growth of GDP and earnings which should lead to higher valuations. The Schwab International Equity ETF (NYSEARCA: SCHF ) is one of my top choices for international diversification. The fund provides exposure to developed international markets with great diversification in the holdings. There are 1226 individual holdings in the fund and yet the expense ratio is only .08%. My criteria for picking top international funds are fairly. The top allocations are Japan and the United Kingdom which combine to be about 40% of the holdings. While I like to see some additional diversification, I can handle that by simply adding a couple other international ETFs to fill out the position. I’m already long on SCHF, but the position is only a very small part of my portfolio. I intend to change that over the winter as I want to shift my portfolio to have a larger allocation towards international equity at the cost of domestic equity. My preferred strategy for making these allocations is generally to leave active limit orders to buy more shares. If the market turns down in a hard way, that means I’ll find myself in before it gets very low. I counter that problem by allocating more cash away from my checking account and into my brokerage account whenever I’m seeing new 1 year lows. Why I want International Since I’m currently underweight on international, it would be reasonable to assume that I simply want to reach a more balanced allocation. However, my desire to raise the international allocation is based off a belief that international equity should be in position for some solid performance. As an mREIT analyst, watching the yield curves is a major part of my research. I’m also keeping an eye on actions by the Federal Reserve and some of the economic indicators. It is my opinion that the Federal Reserve is intent on raising short term rates even if raising the rates runs contrary to their dual mandate. They wish to remain relevant, but their constant talk of raising rates has only created uncertainty. Central Banks Around the World If investors look at central bank policies abroad, they are doing the exact opposite of the Federal Reserve. They are pushing to lower interest rates as far as possible. Some countries are already using NIRP, which is “Negative Interest Rate Policy”. For decades there has been a simple economic understanding that it is impossible to get investors to lock in negative nominal interest rates. It was also believed that investors would not accept negative real interest rates, but the yield on TIPS (treasury inflation protected securities) has clearly proven that negative real interest rates were readily accepted. In negative interest rate policy we see that negative rates can occur as well. The theory that rates could not turn negative was based off the idea that the owners of cash could simply stuff it in their mattress rather than accepting a negative rate. The banks have learned that stuffing billions into the mattress is not viable. There is a cost to protect cash. Because there is a cost, it is possible for the negative interest rates to be the cheapest option available. Resulting Yields Because central banks have taken very different policies in both their talk and their actions, the interest rates around the world are materially different. To demonstrate, I’d like to present charts showing the 10 year treasury yields in several countries. (click to enlarge) The rate on a 10 year treasury bond for the United States is 2.27%. The top two allocations in SCHF were Japan has a 10 year yield of .30% and the United Kingdom which has a yield of 2.01%. To make it simpler to see the relevant rates for the countries that are represented in SCHF’s portfolio, I built the following chart. The heaviest allocations are on the left and the smaller allocations are on the right. This list is not exhaustive, but it provides the top several countries: (click to enlarge) To put that in perspective, Australia is the only foreign country in the top 10 allocations for SCHF that has a materially higher 10 year rate than the United States. South Korea’s 10 year rate was very slightly higher, but the difference was small enough that it could easily flip back and forth in a day. Interpretation The Federal Reserve is intent on raising short term rates and their desire to raise short term rates combined with a positive employment report about a week ago resulted in domestic treasury rates moving significantly higher. The Federal Reserve has not even acted yet, but already our yields are materially higher than most developed markets. To be fair, there are many emerging markets with higher treasury yields. How many investors do you know that consider the United States to be an emerging market rather than a developed one? In my opinion, these other developed countries represent the best comparison of peers. Because I believe the central banks in international markets are doing a better job of handling economic policy, I believe those economies have an advantage for establishing stronger performance moving forward. I believe the expansionary policies will result in a faster growth rate of GDP and higher sales for companies in those locations should translate to stronger earnings and higher valuations. Conclusion SCHF is a diversified low fee index fund for gaining exposure to developed international markets. The top allocations in the fund are to countries that are showing materially lower treasury yields than the United States. The expansionary policies in those countries provide a tailwind to growth that should drive up their GDP. When those economies are expanding, I expect the strength in sales to lead to stronger earnings and higher valuations. Therefore, I will aim to increase my international allocations over the next few months. I may place some limit orders over the weekend to begin the process of acquiring more shares.