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Can one fund be a diversified portfolio?

Among target-date fund investors in retirement plans at Vanguard, more than half invest in at least one other fund.

Some may wonder whether having just one fund means their investment mix isn't diversified.

If you're among that group, it's instructive to remember how target-date funds, such as Vanguard Target Retirement Funds, are designed to work.

Each Target Retirement Fund invests in up to seven other Vanguard funds, which means it's a broadly diversified investment mix on its own. In addition, Target Retirement Funds are designed to keep your assets invested appropriately for your stage in life, up to and including your retirement years.

Investments in Target Retirement Funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments (stocks) to more conservative ones (bonds and short-term reserves) based on its target date. An investment in a Target Retirement Fund is not guaranteed at any time, including on or after the target date.

In pursuit of diversification

Some investors who own target-date funds alongside other funds may be trying to diversify an already-diversified portfolio. That's among the findings of a December 2009 study by the nonprofit Employee Benefit Research Institute (EBRI).

EBRI's study of more than 750,000 target-date fund users in nearly 14,000 401(k) plans found that 55% held funds in addition to target-date funds at the end of 2007.

Among target-date fund investors in retirement plans at Vanguard, 54% invested in more than a single target-date fund, according to How America Saves 2009.

Is your investment mix diversified?

If you invest in a Target Retirement Fund, you have a broadly diversified asset mix in just one fund.

Consider Vanguard Target Retirement 2020 Fund, designed for investors planning to retire between 2018 and 2022. It owns more than 5,000 U.S. and international stocks and more than 3,000 U.S. investment-grade bonds.

Here's its makeup, as of December 31, 2009:

Vanguard Target Retirement 2020 Fund

Underlying fund

Fund investments

Percentage of 2020 Fund

Vanguard Total Stock Market Index Fund Investor Shares

More than 3,000 stocks representative of the whole U.S. market.

54.5%

Vanguard Total Bond Market II Index Fund Investor Shares

More than 3,000 bonds representative of the broad U.S. investment-grade market.

31.9%

Vanguard European Stock Index Fund Investor Shares

Nearly 500 stocks of companies in 16 major markets in Europe.

6.9%

Vanguard Pacific Stock Index Fund Investor Shares

Nearly 500 stocks of companies in Japan, Australia, Hong Kong, New Zealand, and Singapore.

3.4%

Vanguard Emerging Markets Stock Index Fund Investor Shares

More than 800 stocks of companies in countries including Brazil, Russia, India, China, Korea, and Taiwan.

3.3%

 

One fund can be a sound strategy

Having no plan investments other than a target-date fund can be a sound strategy, says John Ameriks, director of Vanguard Investment Counseling & Research.

Yet an investor may own other funds for any number of reasons. "We know people use balanced, diversified portfolios in many ways," Ameriks says.

For example, some investors may want to have the bulk of their retirement plan assets managed professionally in a target-date fund, while adding some exposure to an investment that isn't part of the fund.

Why some own more than one

Some investors who own both a target-date fund and other funds may do so without realizing it, says Cynthia Pagliaro, a senior research analyst in the Vanguard Center for Retirement Research.

Pagliaro studied Vanguard retirement-plan participants who owned target-date funds and at least one other fund for the first time in 2009. She found that four in ten did so through an employer's transactions.

Such transactions could include a contribution of company stock to an employee's account and fund lineup changes that invest plan participants' money in target-date funds unless they opt out.

But if you're looking for a diversified investment mix, you can find it in a single target-date fund.

Notes:

  • All investments are subject to risk. Foreign investing involves additional risks including currency fluctuations and political uncertainty. Stocks of companies in emerging markets are generally more risky than stocks of companies in developed countries.
  • Investments in bond funds are subject to interest rate, credit, and inflation risk.
  • Diversification does not ensure a profit or protect against a loss in a declining market.

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