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by Dan Wiener Editor, The Independent Adviser for Vanguard Investors December 29, 2003

The biggest questions facing investors baffled by all these life-cycle funds are, (1) whether life-cycle funds are even appropriate investments, and (2) if so, which one is best.

At Vanguard, the all-in-one investing field just got a lot more crowded for those who would rather buy one, super-diversified fund rather than building their own portfolio.

Five of the newer Target Retirement funds (all but Target Retirement Income) are known as target maturity funds. Their allocations change over time; eventually moving to the same allocation, which is the allocation used for Target Retirement Income. (Vanguard has said that when a Target Retirement fund's allocation finally reaches that of the Income fund, their assets could well be merged. This would increase efficiencies and also eliminate investor confusion. Imagine being an investor in Target Retirement 2005 in the year 2008, for instance.)

Finally, life-cycle funds rely heavily on indexing for their underlying investments. Only the two most conservative Target Retirement funds, Target Retirement 2005 and Target Retirement 2015 currently use the actively managed Inflation-Protected Securities. (Of course, within something less than 10 years we can expect to see Target Retirement 2025 begin to allocate some assets to the inflation fund.)

So, who are these funds for? Vanguard believes that the Target Retirement funds are for the most unsophisticated of investors; a person who wants to pick a fund and never have to look at his or her investments again, for as long as 40 years or more. Or as they put it, the funds are for “initial investors, not experienced or sophisticated investors.”

Obviously, if you simply tell someone to pick the fund whose date most closely matches his or her expected year of retirement, you've made things ultra simple. Vanguard hopes that many corporate 401(k) plans will pick up the Target Retirement funds as options for employees. Maybe the simple approach is simply what corporate benefits managers are looking for.

What's missing, of course, is the ability for investors to choose their allocation and the funds they will use to achieve that allocation. And, there's little to no discussion of risks. Since the Target Retirement funds are so new, most people simply ignore the risk question. That's a mistake that could prevent you from getting into the best funds.

Of course, I have a fundamental problem with funds of Vanguard funds that don't select the best Vanguard has to offer. I also have a problem with funds of index funds. They simply don't perform. A comparison with my Model Portfolios will show that.

However, one place where I think investors really can do better without much work is in Target Retirement Income (VTINX). Assume you want an allocation that looks just like Vanguard's offering, but you pick slightly better funds. With little effort you can produce a portfolio that will generate a higher yield, with lower risk, and higher returns. But it won't be completely indexed.

I'm earning a higher yield with my GNMA fund, which has outperformed Total Bond Market over time. (If replacing Total Bond Market entirely is too much for you, split them half-and-half so you don't fall too far from the Target fund's allocation.) Replace the money market with a bond fund, which is what Vanguard already does in its other static allocation funds. And for your stock exposure, pick the fund that gives you the large-caps of Total Stock Market, but beats them (Growth & Income) and add a high-yield smaller-stock fund, Convertible Securities . That's not too tough, and the potential returns are significantly higher.

Again, you and I don't need these life-cycle funds. Retirement plan investors whose benefits managers pick these over Vanguard's excellent managed and indexed funds, are simply copping out. Don't let your plan be reduced to a few funds-of-funds. You can do better.

Put Dan Wiener's Model Portfolios to work for you so that you can be sure to get into the best Vanguard funds with less risk. More of Dan's advice is available on the www.AdviserOnline.com members-only website. For subscription information, see Become A Member.

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