Vanguard Adjusts International Equity in Target Retirement and Other Balanced Funds

Vanguard has announced that they're increasing international equity exposure of Target Retirement, LifeStrategy Funds, and the STAR Fund from about 20% of equities to approximately 30% of equities.    This is addition to the move of holding Vanguard Total International Stock Index Fund (VGTSX) instead of Vanguard European Stock Index Fund, Vanguard Pacific Stock Index Fund, and Vanguard Emerging Markets Stock Index Fund in the funds in an effort to simplify the holdings.  Lastly, this is all in conjunction with the changes to the International Stock fund's change from tracking the MSCI® EAFE + Emerging Markets Index to now tracking the MSCI All Country World ex USA Investable Market Index.  The new index covers 98% of the world's non-US markets and includes small-capitalization companies as well as Canada and Israel unlike before.  Not only that but Vanguard plans to introduce 5 share classes of the fund, including an ETF (with a 0.20% ER).  Previously, one had to invest in FTSE All-World ex-US to get access to the ETF VEU (0.25% ER).

Personally, I like the changes.  I always thought 20% international exposure was a bit low, especially considering Vanguard's own recommendation of 20-40%.  Here is Vanguard's rational courtesy of John Ameriks, a Vanguard principal and head of Vanguard Investment Counseling & Research:
First, a detailed quantitative analysis suggested that U.S. investors obtain maximum diversification benefits when non-U.S. stocks make up 20% to 40% of their equity portfolios. Related to that is the growth of non-U.S. stocks as a percentage of the global equity market and the declining costs of implementing and managing non-U.S. equity positions.


In addition, it is our view that we will be able to make this change with minimal transaction costs to investors at this time. Fundamentally, we believe that a modestly higher allocation to international equities has the potential to improve diversification and reduce volatility in these portfolios over the long term. Since 2006, Vanguard has advocated that U.S. investors hold 20% to 40% of their equity portfolios in non-U.S. stocks. We continue to hold that view, and this change places these funds firmly in the middle of that range.
While some may argue this is performance chasing (international markets have performed much better than US markets in the past decade), I would argue that their previous allocation was out of tune with their own research and the steadily increasing market capitalization of foreign markets (now 56% of the world market; if you want to track that, simply invest in VT).  In my mind, 30% is more reasonable to offer the potential of greater returns and increased diversification (nothing is guaranteed, of course).  I personally hold about 40% of my equities in international funds.  It's also a nice addition that this index will now include small-caps (much like the difference between the S&P 500 and the Wilshire 5000).  It is now not imperative to have a separate small-cap foreign holding unless you purposefully want to overweight.

Previously, while the single Target Retirement fund offered a great simple solution for investors who want to set it and forget it, it notably lacked foreign small-caps and it's exposure to international markets was a bit low. Now it seems to be a more viable all-in-one solution.  That comes with a couple of caveats.  Firstly, the stock/bond allocation hasn't changed so one should look at those when determining which fund best suits his or her objectives rather than looking at the end date.  Others do not find the shift from stocks to bonds to be appropriate, and rather shift from equities to bonds earlier in their lives.  Finally, I personally like some exposure to REITs and that still is not included in the fund.  However, you could do much worse than the Target Retirement Funds.  They are simple all-in-solutions that are inexpensive and highly diversified.  I am glad Vanguard made the changes to not only increase the foreign allocation, but also including small-caps, Canada, and Israel by following a different index for the international fund.  

Good job Vanguard!

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