Sunday, April 8, 2012

Vanguard LifeStrategy Funds

In previous posts I've recommended Vanguard Target Retirement funds (minimum investment $1,000) as a way to own a broadly-diversified, low-cost portfolio using a single mutual fund. Vanguard offers another group of all-in-one funds that are worth considering: the Vanguard LifeStrategy Funds. The main difference is that the LifeStrategy funds maintain a constant asset allocation (ratio of stocks to bonds), whereas the Target Retirement funds gradually reduce the stock/bond ratio as you approach retirement. Also, the minimum investment in a LifeStrategy fund is $3,000.

There are four funds in the Vanguard LifeStrategy group of funds:
  • LifeStrategy Income Fund: 20% stocks, 80% bonds
  • LifeStrategy Conservative Growth Fund: 40% stocks, 60% bonds
  • LifeStrategy Moderate Growth Fund: 60% stocks, 40% bonds
  • LifeStrategy Growth Fund: 80% stocks, 20% bonds
Since these funds maintain a constant stock/bond allocation, they are appropriate for investors who do not want their ratio of stocks to bonds to decline over the next few years. For example, a young investor may want to maintain a stock/bond ratio of 80/20 for twenty years, then consider reducing it to 60/40. The LifeStrategy Growth fund would be the fund to use now. By contrast, if you started with the Target Retirement 2030 fund, your stock/bond ratio would be about 80/20 now, but in ten years it would have declined to about 70/30.

Or you could be investing for a shorter-term goal than retirement, and want to hold a conservative stock/bond ratio of 20/80; the LifeStrategy Income Fund fits the bill.

Finally, there is some evidence that holding a constant stock/bond ratio throughout your investing lifetime is a superior strategy compared to decreasing your stock allocation over time. I'm not convinced, but if it makes sense to you, the LifeStrategy Moderate Growth fund might be a good choice.

If you like the idea of using a single all-in-one fund, you should decide which strategy is appropriate for you, and pick either a LifeStrategy fund or a Target Retirement fund; there is no need to own both types of funds. If you're not sure which approach makes more sense for you, just pick one; you can always change your mind later and exchange from one type of fund to the other, especially if this is in an IRA account, where there are no tax consequences of selling. If you have less than $3,000 to invest, the choice is easy: use a Target Retirement fund, since the minimum investment is only $1,000.

As with Target Retirement funds, LifeStrategy funds are best held in a tax-advantaged account, like an IRA (Roth or traditional) or 401k/403b (if you are lucky enough to have one of these funds in your plan). This is because the bonds held in the funds distribute dividends that are taxable at regular income tax rates. To learn more about tax-efficient placement of assets (also called asset location), read the excellent Bogleheads Wiki article Principles of Tax-Efficient Fund Placement.

Investing can be simple. One of the hardest parts is figuring out how much risk and what types of risk are appropriate for you to take. Once you've done that, it can be as simple as investing in a single Vanguard LifeStrategy or Target Retirement fund.