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Targeting Lower Costs

Jonathan Clements  |  December 12, 2015

IN A WORLD overflowing with mutual funds, I’d like to see Vanguard Group add a few more. How about 12?

I’m a fan of target-date retirement funds, which offer diversified portfolios geared toward folks retiring at or near the year specified in the fund’s name. But Vanguard’s existing 12 funds have a big problem: their annual expenses.

To be sure, the funds’ costs are tiny compared to most others available. Suppose you buy Vanguard Target Retirement 2030, which recently had a mix of 44.8% Vanguard Total Stock Market Index Fund, 29.5% Vanguard Total International Stock Index Fund, 18% Vanguard Total Bond Market Index Fund and 7.7% Vanguard Total International Bond Index Fund. The 2030 fund doesn’t charge any expenses itself, but you incur the expenses of the underlying funds, which come to 0.17%, equal to 17 cents a year for every $100 invested.

Problem is, the 2030 fund owns the Investor Share class of these other funds, each of which typically has a $3,000 minimum investment. But the expenses are even lower for the Admiral Share class, which require a $10,000 minimum investment. The upshot: I can build my own 2030 target-date fund by purchasing the Admiral Shares of the underlying funds, and my weighted average expenses would be 0.09%.

Now imagine that Vanguard offered its target-date funds with an Admiral Share class. To do this, Vanguard would have to launch a new set of funds, rather than adding an Admiral Share class to its existing funds. The reason: As funds-of-funds, Vanguard’s target-date funds pick up the expenses of the underlying funds, so there’s no way to have two share classes with different pricing.

Setting up new target-date funds might sound troublesome, but Vanguard has done it before. In June, Vanguard launched 12 target-date funds that are available through employer retirement plans. Each fund charges a slim 0.1% a year.

Suppose funds like these were available to individuals who pony up, say, a $10,000 or $20,000 investment minimum, with the funds owning the Admiral Share class of the underlying funds. Suddenly, my financial life would be a whole lot easier. Instead of buying the four underlying funds, I could purchase a single target-date fund and make it my core holding. For added diversification, I would probably add smaller positions in a few other funds, such as investing in small-cap international, real-estate investment trusts and U.S. small-cap value. Still, my portfolio would be notably simpler than it is right now.

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