About the author: The following is a guest article written by Kevin from No Debt Plan. He writes to help readers eliminate debt, learn how to budget and save, and move themselves towards financial freedom.

The first investment we made in one of our Roth IRAs was in a Vanguard Target Retirement fund. Generally target date retirement funds make good investments; if you are just starting to save for retirement it’s a great investment. Flexo recently shared his reservations about these investments, but today I’ll give you four reasons why we like them.

1. It’s an easy start.
2. Low investment needed to start.
3. You get instant diversification.
4. The fund automatically rebalances based on your age.

Let’s look at these individually.

An easy start. You need only one account (Roth IRA, Traditional IRA, taxable investment account, etc.). You invest in one fund. That’s pretty easy to get going and removes a bunch of hurdles.

Low investment needed to start. With any target retirement fund, the only start up cost you have is your minimum investment and then associated expense fees. We opened our Roth IRA with Vanguard because they are known for having low expense fees, and the minimum investments are only $3,000. Once you invest your first $3,000, you can add as little as $100 to your account after that. The kicker is you only need the one fund to get started, which leads us to…

Instant Diversification. The reason you only need one fund starting out, is a target retirement fund gives you a great deal of diversification right off the bat. Let’s take a look at Vanguard’s Target Retirement 2050 Fund (VFIFX) that we are currently invested in:

• 71.61% Vanguard Total Stock Market
• 10.09% Vanguard Total Bond Market
• 9.97% Vanguard European Stock Index
• 4.39% Vanguard Pacific Stock Index
• 3.62% Vanguard Emerging Markets Index
• 0.16% Vanguard Total Stock Market ETF

With one fund, you’re invested in 5 other major investments. Starting out you probably want a large amount of US and International stock exposure. Even if you just wanted these two things you would need two funds to get that diversification. Two funds means two minimum investments. Add additional funds and you add additional minimum investments. Not so with the target retirement fund. One minimum investment and you suddenly have instant diversification.

Automatic Rebalancing. Rebalancing is the act of sitting down once per year and adjusting your portfolio toward your target asset allocation. Let’s say you hold two funds because you want a 50% US stock exposure and 50% International stock exposure. During the last year, it is unlikely the funds have gained and lost exactly the same. So you end the year and US stocks have been up more than International stocks. Your current portfolio weight is 53% US and 47% International.

Doesn’t sound like a big deal, right? Just 3%. Well, over time that gap can get larger and larger until one day you find yourself with a 75/25 allocation—way out of whack.

With a target retirement fund, you don’t have to worry about rebalancing. If 100% of your portfolio was in the fund (not a recommendation, just an example), the fund will rebalance for you every year. As time marches on you will get closer and closer to the target date for the fund. As you get closer, the fund adjusts the portfolio for you to be more conservative.

Let’s compare two of Vanguard’s funds, the Target Retirement 2010 (VTENX) and Target Retirement 2050, to make the point clear. We expect the 2010 fund to have fewer stocks and more bonds/income generating investments than the 2050 portfolio listed above. The 2010 investments include:

• 44.08% Vanguard Total Stock Market Index
• 40.28% Vanguard Total Bond Market Index
• 6.18% Vanguard European Stock Index
• 4.43% Vanguard Inflation-Protected Securities
• 2.69% Vanguard Pacific Stock Index
• 2.27% Vanguard Emerging Markets Stock Index
• 0.05% Vanguard Total Stock Market ETF

The 2010 fund is 55.27% stocks and 44.73% non-stock investments. The 2050 fund is 89.91% stocks and 10.09% bonds. An obviously difference. Over time, the 2050 fund will start to look more and more like the 2010 fund.

What are you waiting for? For all of you new investors out there, I honestly think a Vanguard Target Retirement Fund is one of the best initial investments you could make.

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Target retirement funds are increasing in popularity. The funds, and they may be called “lifecycle funds” or “target date funds” or “age-based funds” or a variety of other terms are mutual funds comprising other mutual funds. The allocation percentages of the constituent mutual funds change as time progresses, theoretically becoming more conservative as you approach your target.

For example, the Vanguard Target Retirement 2050 Fund (VFIFX) is a mutual fund of funds designed for people who expect to retire in the year 2050. You would expect an investment—one that is designed to mirror your investing strategy based on your time horizon—to be quite aggressive in order to make the most of the decades between now and the time you need to access its value.

This reveals the first problem I have with target retirement funds: they are often too conservative. VFIFX contains five other Vanguard mutual funds: Vanguard Total Stock Market Index Fund, Vanguard Total Bond Market Index Fund, Vanguard European Stock Market Index Fund, Vanguard Pacific Stock Index Fund, and Vanguard Emerging Markets Stock Index Fund. As of today, 72% of the fund is invested in the Total Stock Market, 10% is invested in the Total Bond Market, and the remaining 18% is split between the others in amounts hardly meaningful.

I don’t see this as aggressive enough for someone who has such a long time horizon. I would suggest eliminating the bond component entirely and distributing the rest towards the international funds.

My second issue with target retirement funds is how it could lull an investor into a false sense of safety and security. While creating a hands-off approach to investing, it encourages buying and holding which is great for long-term success, but it opens the door to complacency. Your reallocations are on auto-pilot, so if you decide to change your time horizon, you may find yourself under or over-exposed to risk. Also, Vanguard, or which ever management company you choose for your target retirement fund, may decide to change strategies in the future, to the point where their guidelines no longer match your expectations.

Target retirement funds to encompass your entire portfolio. If you’ve chosen the Vanguard Target Retirement 2050 Fund for your entire 401(k) election, but you have a Roth IRA where this fund is not available, then you’re modifying your asset allocation away from that prescribed by Vanguard. If you are comfortable with Vanguard’s exposure to equities in their fund but you decide to invest in VTSMX separately in your Roth IRA, you’ve disturbed your overall asset allocation and opened yourself up to risk you may not have intended for your retirement funds.

Fund managing companies can’t seem to agree on the most appropriate asset allocation for a certain target. I mentioned Vanguard’s current allocation rule for its “2050” fund. Fidelity has a different strategy for those retiring the same year. The Fidelity Freedom 2050 Fund (FFFHX) invests in 68.5% domestic stock funds, 20.9% international stock funds, and 10.5% bond funds. Overall, this is similar to to Vanguard fund of funds, but the specific composition of the international portion provides a strong enough contrast that could have profound effects over 40 years of investment.

The fees for target retirement funds are usually a combination of the fees of the underlying investments. Rarely, a target retirement fund will add a management fee in addition to the feeds already charged by the funds held. Pay attention to these fees, because they will eat into the value of your investment. With a distant target like 2050, the fees eat into your returns even more.

Money Magazine is recommending that those wishing to build their net worth over a long period of time simplify matters by putting all their eggs into seven baskets in the form of mutual funds.

1. Fidelity Spartan 500 Index (FSMKX). This fund’s total expense ratio is a minuscule 0.10%. It tracks the S&P 500 index.

2. Vanguard Total International Stock Index (VGTSX). “Nearly 60% of the world’s stock market value resides in companies outside our borders,” so you’ll want a piece of that action.

3. T. Rowe Price New Horizons (PRNHX). New Horizons is a small company stock fund. There are periods of time in which small company stocks have outperformed the market at large. This isn’t an index fund, though, so expect to pay an expense ratio of 0.79%, still low for managed funds.

4. Vanguard Value Index (VIVAX) . If you pay attention to value funds, your investments will return dividends. Literally. This fund currently offers a dividend yield of 2.94%.

5. Vanguard Total Bond Market Index (VBMFX). Got bonds? I don’t. But if your asset allocation calls for bonds, this fund beat the industry average by 14% over the past 10 years and its expense ratio is 0.20%.

6. Vanguard Inflation-Protected Securities Fund (VIPSX). First of all, official government inflation statistics underestimate the real increase in prices we see every year, partly because those who calculate the statistics assume Americans “trade down” to lower quality products when prices get high. Thus, inflation-protected securities are likely misguided. Money Magazine has nevertheless included them among the other suggestions.

7. Fidelity Cash Reserves (FDRXX). Cash reserves are good for when you spot a buying opportunity in the market and need flexibility and liquidity to jump. A money market fund like this is decent for at least part of your emergency fund. Personally, since I have some of my retirement accounts at Vanguard, I chose Money Magazine’s alternate, VMMXX. This Vanguard fund features an expense ratio of 0.24% compared to Fidelity’s 0.40%.

Probably more important than the specific funds is the overall asset allocation strategy. Investors spend a lot of time talking about investments, analyzing and choosing the best funds that will help us reach our goals, but asset allocation is just as important. If an investor ignores his allocations, her investments might not provide the results.

Photo credit: epicharmus
The Only 7 Investments You Need [Money Magazine]

Do investment companies need to market to “Generation X” and “Generation Y” differently than the general investing public? Would new, “hip” investment products encourage individuals falling within these particular demographics to care about their financial future? Thrasher Capital Management was founded on the principle that these markets, as well as minorities, are currently under served by the financial industry.

[The Thraser Funds investment model] seeks to capitalize on the convergence of what the firm believes to be global, generational, and socioeconomic dynamics that touch an array of industries: the Baby Boomer’s increased life expectancy, elongated career life cycle, along with Generations X and Y’s increased access to capital.

To approach this investment model, Thrasher created the GendeX Mutual Fund, and is marketing the investment to Generation X and Generation Y, individuals who do not seem to fit in with the generally-accepted notion of “investor.” A visit to the Thrasher Funds website makes this clear. The first thing you’ll see is a photograph of a group of “non-conformists.” Their individuality is indicated by the diversity of clothing and stature/stance, with no one looking like your typical “professional” investor. “They invest. Do you?” Peer pressure is a powerful force.

If you like, there is the option to peruse the Thrasher Funds website with a soundtrack designed especially for Thrasher Funds’ customers. Play the music at the bottom of the website to listen to a smooth track. It makes you wonder if those who market to youth’s individuality really believe in that individuality.

So what about the GendeX mutual fund [GENDX]? Investors should look past all this marketing and determine whether the investment itself is worthwhile. Their website is not yet ready for prime time, so those seeking data on past performance are pointed to Yahoo Finance’s website. Information there is sparse as well. In GendeX’s short history, it has followed the S&P closely. As I tried to find more information, I discovered that Google Finance has no information on the fund at all. The symbol and fund name are not recognized by Google’s vast financial database.

GendeX invests in companies that are admired by their demographics, such as Apple, Louis Vuitton, Gucci, Volkswagen, Coca Cola, and Nike, among other companies that appeal to the masses, like Time Warner and Google.

The fund features an expense ratio of 1.50%, above average and eight times the expense ratio of VFINX, Vanguard’s index fund that follows the S&P 500. The fees keep on coming. While the fund is happy to accept investors with a low $100 minimum if combined with an automatic investment plan of at least $50 per month, you’ll have to pay $2 per month if your account value is less than $2,500. That’s basically an extra 1% fee or more. If you withdraw money from the fund that has not been invested for over 12 months, you’ll face a 2% redemption fee. Redemption fees are usually used to recoup costs for selling investments with hard-to-find buyers; considering that the underlying investments of GendeX are actively traded, I don’t see a need for this redemption fee.

So will you be cutting back on skateboards and tattoos in order to invest in GendeX? If so, leave a message on Thrasher Funds’ MySpace page where “investing is a party” with 445 other friends.

As someone on the young side of Generation X, I’ll stick with index mutual funds, as boring and unmarketable as they are.