Vanguard Changes Course

I’m a big fan of Jack Bogle and Vanguard, so I was interested to see that Vanguard has made some fairly substantial changes to their Target Date Funds (TDFs).

A TDF is a mutual fund that is designed for working people who know roughly when they will retire. For example, if I want to retire at 67 when my Social Security payments begin, I would buy a 2040 TDF.

As I get older and closer to my target retirement date, the TDF automatically becomes more conservative, reducing stocks and adding to bonds.

TDFs aren’t inherently good or bad. I think they are fine products, especially for small investors when they are reasonably priced like Vanguards products.

I like looking at the asset allocations in other firms TDFs because it gives a good sense of how the firm thinks that you should invest (there are other factors, but it’s a reasonable proxy).

We have our own models, but I keep track of what a lot of firms are doing, looking for ideas and making sure we’re not way in left field (we’re not).

Vanguard’s big change is that they are dramatically upping their allocation to non-US stocks. Currently, they invest 30 percent of their stock allocation internationally and they are bumping that up 10 percentage points to 40 percent.

For reference, our non-US stock weighting is about 25 percent of stocks, somewhat less than their current allocation and meaningfully less than their intended weight.

Vanguard says that they are increasing their international allocation to reduce single country risk (which would have to refer to the US) and because the costs of investing overseas has fallen dramatically.

Although they don’t say as much, I think there is another factor at work, which is that they think that returns from overseas stocks are likely to be higher outside the US in the next 10 years.

Of course, I may be completely wrong about this, but it’s no secret that foreign stocks are a lot cheaper than US stocks – I’ve written about that twice recently, here and here.

And, I’m not the only one either – a number of market observers are making the same call, including Vanguard in their annually published Economic and Investment Outlook.

The last Outlook was published last December and they forecast global stock returns around five to eight percent in the next ten years (along with a much wider, though less likely range of returns).

For good reason, Vanguard makes it difficult to read their precise average expected return. They don’t want people to take that number as a single point forecast and are making it clear that they don’t have a crystal ball and are only making ballpark estimates.

That said, it’s clear from their chart (which I’m not supposed to republish, otherwise I would show it) that their estimates for non-US stocks are closer to nine percent while their US estimates are closer to six percent.

Last year, people hated their non-US stock exposure because it barely broke even while the S&P 500 earned double digit returns.

It’s easy to look at the news from Europe and Japan and feel nervousness about returns in those countries, which is precisely what makes them attractive from an investment standpoint. As Warren Buffet likes to say, ‘be fearful when others are greedy and greedy when others are fearful.’

Obviously, that’s a lot easier said than done. I don’t imagine that we will be changing our non-US weightings dramatically anytime soon, but I am definitely taking notice of Vanguard’s new position, whatever their reasons may be.