This post was first published at The Humble Dollar
Target-date funds from Vanguard Group are, I believe, fantastic products. My first investment was a $3,000 purchase of Vanguard Target Date 2045 Fund (VTIVX) in late December 2005, shortly after I turned age 18. That was also my first Roth IRA contribution.
A target-date fund is an off-the-shelf globally diversified portfolio that automatically becomes more conservative over time. You don’t have to do any fiddling with the allocation, such as rebalancing or adjusting down your portfolio’s risk level. It’s a terrific, hands-off investment vehicle for building long-term wealth.
I’m concerned at the moment, however. Last year featured monster gains in the S&P 500 and NASDAQ 100. Even the broad Vanguard Total Stock Market ETF (NYSE:VTI)) returned almost 26% in 2021. By contrast, Vanguard Target Retirement 2060 Fund (VTTSX) was up “just” 16%. While that gain is nothing to sniff at, relative return differences can be powerful. And dangerous.
I fear that some investors will see 2021 returns early this year and simply allocate to the biggest winners. That might be fine—owning a low-cost S&P 500 index fund will probably work out okay over the decades ahead. Still, a large-cap U.S. index fund misses out on the diversification benefits that come with owning other stock market segments, such as U.S. small-cap stocks and foreign shares.
Recency bias plagues us as investors. If we aren’t careful, we can pick the hot index fund one year, and then ditch it when it has the inevitable stretch of sour returns compared to other index funds. Target-date funds help keep that kind of performance chasing in check.
My tip: As you review your portfolio, don’t get lulled into thinking that what worked over the past few years will keep winning. A diversified, low-cost approach that doesn’t require tinkering is a solid strategy for long-term investment success.