Vanguard Target Retirement Funds – Surprise 10%+ Year-End NAV Drop and Capital Gains Distribution Explained

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The Vanguard Target Retirement Funds are one of the largest “set-and-forget” mutual funds that own a mix of stocks and bonds that automatically adjust over time based on your targeted retirement year, with combined assets across the institutional and retail classes of over $600 billion.

Reader rp pointed out that on December 30th, 2021, many Vanguard Target Retirement funds had their price (NAV) drop by over 10% in a single day! This was mostly the result of an abnormally large year-end long-term and short-term capital gains distribution. Taken from Vanguard’s final year-end estimates PDF:

Here is an example for the Vanguard Target Retirement 2040 Fund (VFORX). The 2021 cap-gains distribution was roughly 40 times as large as for 2020. Yet, other funds with a similar asset allocation like the Vanguard LifeStrategy Funds did not have a similar result. What happened?

Background. A mutual fund is forced to make a capital gains distribution when it sells stocks (or bonds) that have appreciated in value, thus realizing capital gains. There are various reasons why a mutual fund might sell stocks:

  • An actively-managed fund might sell shares of stocks that they believe are over-valued in order to purchase shares of another business.
  • An index fund might have to sell shares if the underlying index changes. By definition, an index fund must track an index. For example, sometimes the S&P 500 will remove a company from its index.
  • A balanced mutual fund might rebalance between stocks and bonds. If the target is 80% stocks and 20% bonds, the fund might sell some stocks after a big bull run in order to buy some bonds and revert back towards the target.
  • A mutual fund has a high number of redemptions (cash outflows), such that the fund has to sell assets in order to come up with the cash to satisfy all those withdrawals.

Vanguard Target Retirement Funds don’t follow an index themselves, as they are a “fund of funds”. That means they are basically a wrapper for the component index funds. For example, the Vanguard Target Retirement 2055 Fund (VFFVX) is composed of:

  • Vanguard Total Stock Market Index Fund Investor Shares 54.90%
  • Vanguard Total International Stock Index Fund Investor Shares 35.50%
  • Vanguard Total Bond Market II Index Fund Investor Shares 6.60%
  • Vanguard Total International Bond Index Fund Investor Shares 2.80%
  • Vanguard Total International Bond II Index Fund 0.20%

However, these underlying funds did not have huge capital gains distributions themselves that might flow through. In fact, the main components had zero capital gains to distribute, while the other distributed tiny amounts less than 1%.

What we have left is that the Target Retirement Fund itself sold some shares of the component index funds. Stocks did go up in 2021, but not nearly enough to warrant such a huge capital gain. Besides, stocks also went up a similar amount in 2020, and as we saw above the 2020 capital gains distribution was 40x smaller.

In addition, the Institutional Target Retirement 2040 fund only had cap gains distributions of 0.39% of NAV. This fund should have the same rebalancing needs as the retail version for individual investors. The rest of the Institutional Target Retirement years had similarly low distributions.

Strange! Thankfully, I found a great clue by “cas” in this Bogleheads thread. From reading the annual reports for VFORX, we find that as of 3/31/21, the net assets for Target Retirement 2040 was about $35 billion. From January through September 2021, over $16 billion of shares were redeemed from the Target Retirement 2040 fund, while only $6 billion were purchased. The underlying investments grew in value, but investors took out a net $10 billion in cash over the first 9 months of 2021! The large capital gains distribution was primarily due to these large net redemptions.

Okay, but again, why? The main problem was that the “Institutional Target Retirement Funds” are not a share class of the “Target Retirement Funds”. In December 2020, Vanguard lowered the plan-level minimum investment requirement for the Institutional Target Retirement Funds to $5 million from $100 million. Now, as long as an employer’s 401k plan had $5 million in assets across the entire plan (not just one person), they could now access the much cheaper Institutional version… a big savings for possibly thousands of small businesses.

Let’s check the annual reports again. Over the same time period that Target Retirement 2040 lost $10 billion in net cash outflows, the Institutional Target Retirement 2040 Fund gained $13 billion in net cash inflows. Coincidence?

Vanguard incentivized small business retirement plans to sell their holdings from Target Retirement in order to buy Institutional Target Retirement funds by offering them a 30% to 50% reduction in fees, and they did so, moving over billions and billions.

Eventually, in September 2021, Vanguard announced that they would merge each of the Vanguard Institutional Target Retirement Funds into its corresponding Target Retirement Fund. The mergers are not scheduled to be completed until February 2022. There may be more outflows until then. A merger would not have created any forced selling, so why not do this in the first place?

I wonder if Vanguard made a mistake and they simply didn’t realize this would create large outflows. Or perhaps they just didn’t care? Either way, it’s another recent blemish on their record. The order and time delay in which they did things indirectly hurt the individual taxable investors of Target Retirement funds. They should have simply merged the two series in the first place.

This is why the DIY investor should strongly consider only investing in the “raw materials” and “cook from scratch”. VTI, VXUS, and BND ETFs can be held at any brokerage firm, bought and sold for free, distributed tax-efficiently between 401k/IRA and taxable, and are available for ETF-pair tax-loss harvesting in a taxable account. On the other hand, this is something of a one-time event, so you may value the simplicity of Target Retirement funds above the potential drawbacks.

If you like the idea of “auto-pilot” but also want to be be only one allowed to program the autopilot, check out out M1 Finance and their pies (which you can always break back up into component ETFs) as well as Utah My529 and their “customized glide path” option for college savings. I don’t like the fact that Vanguard can always change up their target asset allocation to whatever is trendy. (I have the same issues with the robo-advisors like Wealthfront and Betterment.)

Summary. Vanguard Target Retirement Funds (Investor shares) made large capital gains distributions at the end of 2021. This was mostly due to large outflows from Target Retirement Funds (owned by individual investors and small businesses) into their separate Institutional Target Retirement Funds, as Vanguard lowered the minimums for the Institutional funds from $100 million to $5 million in December 2020. This appears to have forced the Target Retirement funds so sell their investments and incur large capital gains.

If you hold Target Retirement funds in a tax-deferred accounts like 401k/403b/IRA, this has no taxable effect on you. The net asset value (NAV) dropped by a certain amount, and you received a distribution for the same amount. You most likely have it set to reinvest immediately anyway. However, if you held this in a taxable account, you received a taxable distribution. You now owe some extra tax and lost the ability to compound that money into the future. It’s not a disaster, but it did hurt your returns a little, in my view unnecessarily as Vanguard could have handled things differently on their end.

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  1. Thanks for the post Jonathan! I have good sized holdings in these funds and noticed a big dip and subsequent rebound in my overall net worth trends, and that explains it. Fortunately, my holdings are in IRA and 401(k) accounts, so I won’t take a tax hit. But I agree, Vanguard should have just merged the funds to mitigate this massive selloff.

  2. Hi Jonathan, will you still recommend Vanguard TDF’s to your family and in general? You have always been an advocate of TDF’s in past posts. Vanguard knew what they were doing. IMHO they know most people hold TDF’s in tax advantaged accounts and assumed the vast majority of folks wouldn’t notice and/or care.

    I noticed the eye popping capital gains distribution myself last week. Thanks for writing a blog post about it and confirming I wasn’t making mountains of mole hills! I have been a die-hard Vanguard advocate for years, but in light of the apparent customer service issues and shenanigans like this, there are cracks starting to form. This crap wouldn’t have happened while John Bogle was alive. I hope they get their act together.

    • I agree that Vanguard should have known the likely result of lowering the minimums so drastically from $100 million to $5 million. If not, they would just be stupid instead of negligent.

      I will admit that I am less fond of Target Retirement Funds given the overall direction that Vanguard is taking post-Bogle. I don’t like that I could accumulate 20, 30 years of capital gains and they could tinker with the Target Retirement Funds however they like. VTI will most likely remain VTI, but Target Retirement could shift over the year.

      I still have my own parents in a Vanguard Target Retirement fund in their IRA, but if I had a 20-year-old niece, I might consider how likely they would be to maintain their own VTI/VXUS holdings.

  3. Thank you for breaking this down.

    I have a small percent of my overall profile in a taxable account invested in one of these target date funds from decisions earlier me made, and I’ve held on to them due to not wanting to sell and incur a gains event.

    I recently read discussion that I may be able to transfer those shares directly to another fund or an ETF without incurring a taxable event if I contact Vanguard support. Do you know anything about that possibility?

  4. Well that sucks.

  5. Thank you for your analysis and explanation. I knew the large distribution was happening but I didn’t know why. Shame on Vanguard for handling this so poorly.

  6. Will there be more capital gain distribution when Vanguard merges the investor class and institutional class in Feb?

  7. Ouch. Thanks for the explanation. I have a good chunk of a Vanguard TDF in a taxable account, mostly for convenience. Was looking forward to the lower fees next year. Sadly my massive capital gains bill will now negate many years of those fees. Ugh.

  8. Not sure if I am interpreting this correctly – lost in TDF value does it matches with capital gain distribution?
    Are there any benefit of buying TDF now, assuming this won’t happen again?

  9. Eric Steele says

    I sold all of my VFORX in July 2020, being scared of the pandemic and preferring to sit on the sidelines (assuming everything was going to crash). And then watched with dismay and kicked myself with each passing month as the value went from 38 to 50+. It is correct to think I can jump back in at a discount now that the fund is selling for 42 (compared to 50+ prior to December 28) .

    • Eric Steele says

      To clarify a little bit on my previous post, I should say my retirement investment strategy prior to COVID was to keep all of my retirement money in VFORX, accept that the market will go up and down, and trust over time that I would come out ahead. But when there was the initial dip at the start of the pandemic, I thought “uh oh, here we go with a big drop,” but instead it quickly bounced back to it’s previous high of 38ish, and so I decided to convert everything to cash and sit on the sidelines until the dust settled. But then over the months (and for over a year and counting) the market just went up up up. I was kicking myself for deviating from my Boglehead strategy and considering buying back into VFORX at the higher price and accepting the missed gains as punishment. But it was really hard to stomach buying back in at a 10% premium, then 20%, then 30%. And so my strategy has been to hope and pray for a big correction at some point, buy back in when it went back down to 38, and consider this all a lesson learned. But of course who knows if it’s actually ever going to correct down that low, and maybe 20 years from now I’ll still be sitting with my cash on the sideline wishing I had just “set it and forget it.” But now with this astonishing drop back down to 42 (despite no discernible change in the overall market), I’m wondering if I should consider this accounting oddity a blessing and jump back in, accepting that I missed out on the gain from 38 to 42. But at least I didn’t have to buy back in at 50. Am I thinking of this correctly. I guess another question I have because I don’t understand the explanation for the price drop of VFORX is: If I had bought back in at Christmastime, would I really have just lost 17% of my entire retirement portfolio in one day? Thanks very much for helping me wrap my head around this.

      • Eric, everything in the past is water under the bridge, so I wouldn’t wring your hands over the past (avoid getting caught up in the “sunk cost fallacy”). The price went down in December because they made a distribution that fully compensated for the price drop if you reinvested the shares. So, if you buy now, you’re getting the lower price, but you’re not getting the distribution that led to the lower price. But again, none of that should matter to you at this point. My advice would be to determine your current risk tolerance and consistently invest your portfolio based on that risk tolerance; and don’t make the mistake of trying to time market. Over the long run, trying to time the market is likely to lead to suboptimal returns.

      • I don’t know your age – my advice is assuming you have 5+ years left before retirement. If you’re really close to retirement, you’d be better off consulting a professional than internet strangers.

        Going forward, I strongly recommend you just set and forget. You tried to time the market, and you failed to do it well – which many people do. You’re still trying to time the market, and none of us can tell you if you’re timing it correctly. The whole point of the bogglehead strategy is put it in the market, accept that short-term drops *will* happen, but over the long term your money will gain at a steady rate.

        You could have learned this lesson a lot harder – say, by buying GME at the peak last year.

        On the up-side, you didn’t technically lose money by trying to time the market, you just lost unrealized potential gain. It’s only now, looking backwards, that you can tell you lost out. But again, I assume you didn’t *lose* (much?) money in the sense of pulling out less than you put in. You just lost out on potential. Keep in mind – $1k is $1k – for the most part, it’s less important how many shares that $1k represents, so selling $1k at $30, skipping 6 months, coming back in with $1k at $50 – you’re still holding $1k, and you’re back on the train towards long-term gains.

        You still have the cash, you should get it back in the market, pick a timing strategy, and stick with it.

        As for losing 17% of your retirement portfolio in one day, no. The lost value came back to you as capital gains and dividend, which you very likely would have auto-reinvested in the same exact fund. It’s only if you had this money in a taxable account did it really matter – in which case you would owe taxes on a distribution of >10% of your cash value at the time this happened.

      • I would just add that you are far from the only person that has done this (get out of the market and have a hard time getting back in). Even professionals have done it, they just won’t admit it publicly. Nobody brags about how much money they LOST in Vegas!

        This is what I would tell my family member. I would echo the above and suggest that they make a gradual plan for re-entering the market. Perhaps set a 6 month or 12 month window, and get back into VFORX gradually in that manner. So if they had $12,000, invest $1,000 a month for 12 months. If there is a crash sometime in 2022, they’ll buy some shares at cheaper prices. If things keep going up, the January purchases will go up too. But by the end of 2022, the money will be fully reinvested and back in the game.

        “Experience is what you get when you didn’t get what you wanted. And experience is often the most valuable thing you have to offer.” – Randy Pausch

    • I wouldn’t think of it is a discount. A rough analogy is that one unit of an 4-plex condo was “forced” to be sold. Let’s say there were four units worth $100,000 each, so the total building was worth $400,000 (which was bought years ago for $200,000). For some reason, the owner had to sell one unit for $100,000. The owner lost the unit but gained the market value of $100,000, technically fair. But they also had to pay taxes now on the capital gain and can’t allow the unit to compound in value. They could reinvest their proceeds in another condo, etc, but will have less than $100k left over due to the taxes paid.

      However, buying the remaining 3 units for $300,000 wouldn’t be considered a discount, right?

  10. Tracy O'Brien says

    Newbie here, in light of what happened with the TDF, my question is generally concerning the Vanguard TDF of 2060 that is what I put my 2 son’s into. They are 21 and 24 ,college and worked summers. So I started a Roth account and used Vangaurd 2060. Thinking longevity ,and a plan to get out of the TDF and buy VTSAX or VFIAX . Should there be a bond component to this also?

    • If the money is in a tax-advantaged account (traditional IRA, 401k, 403b, HSA, others?) – then this whole thing didn’t matter at all. It would all be rolled back into the same fund, and the whole event is irrelevant.

      If you’re in a tax advantaged account, and not sure what to do, and not confident you will keep doing it going forward, then these target date funds are still excellent ways to manage your investments. They will do the bonds/stock balancing for you automatically, and you literally don’t have to think about it. Just put more money in every opportunity you can! They aren’t quite as cheap as managing yourself, but they are *almost* as cheap and let you stick to a dependable reliable plan without any action needed on your part.

      That said, if you’re trying to mimic one of the target date funds, Vanguard has a breakdown of how they invest right now (and how they plan to change the investments going forward):

      e.g. for 2045:

      “Portfolio composition” – 53.7% US stock, 34.9% international stock, 7.9% US bond, 3.5% international bond.

      Your sons are young, so their TDFs are going to be very heavy in stock for quite a while. But Vanguard will happily tell you exactly how they are investing if you want to mimic. Just keep in mind – you will probably want to adjust your balance as the years go by.

    • Vanguard’s Target Retirement funds have a (current) glide path that puts investors at 90% stocks and 10% bonds until they are 25 years away from retirement, so 2035 for your Vanguard 2060 fund. So you’ve got a while before anything changes, and I don’t know if I would stress too much about 90% vs 100%, but you may prefer to just go 100% stocks and tell them not to touch it for 10-15 years.

  11. 1 )Target Date Funds have low expenses but since they invest in other funds, the investor also is paying the expenses from the other fund. For the Vanguard investor, both sets of expenses are relatively low.

    2) Instead of investing in bonds which are pay almost nothing and are likely to drop in value in the rising interest rate environment, I have sold my bond funds and am not reinvesting in treasuries when they mature. Instead I am buying dividend paying stocks. If you don’t like picking individual stocks, Vanguard and others have Funds that invest in dividend paying stocks.

    3) I never liked the Retirement advice that says you should have a mix of stocks and bonds based on your age. Again I prefer dividend paying (value) stocks instead of bonds. The never perform as well as the (some) growth stocks but except for bank stocks after the financial crisis, they have generally held up well in both up and down markets and most increase their dividends annually. On occasion, some (notably GE) have reduced their dividends.

    • Wayne Chapin says

      Investors in Target Date funds pay the expense fee of the underlying funds, but not an additional fee on top of that.

      It was Bogle himself in his book “Common Sense on Mutual Funds” that showed you can capture most of the gains of stocks with a balanced fund with less volatility. His book made tons of sense to me. I also liked the idea of automatically adjusting the balance as you get closer to a target retirement date. I’d never properly manage rebalancing, or adjusting for age on my own.

      Also, it is very easy to be “all in on stocks” over the last 11 years. I have seen his before. To think there will never be a time again where bonds become valuable, is unlikely. And then we’ll be going back to the wisdom of people like Bogle.

      All that being said, about 2 years ago, I decided that I have a nice padding with VTTHX, and even if the market did correct 50%, I’d be fine, and I then shifted to investing 100% in Total Stock Market because I can handle the volatility. But, I would not have started my early days of investing this way. VTTHX, even with this stupid crap in 2021, gave me the confidence and stability, to eventually begin investing 100% in stocks.

  12. Wayne Chapin says

    Wow…this is so frustrating. I’m very unhappy with Vanguard right now. I have a large position in VTTHX, in a taxable account, that I have been faithfully contributing to for a long time. This is going to generate an unexpected EXTRA six figure tax bill for me on top of my normal taxes. This will be money I can’t use for other investments…just goes straight to the federal and state governments…and I didn’t even sell any of my mutual fund shares and didn’t need/want the capital. I can’t believe this is how they chose to manage this. Thanks for the great investigative reporting and explaining this. I called in yesterday to find out what was going on, and even as a Flagship customers, was told the hold time estimates were 3 hours. Unreal and sad.

  13. Jeff Cassidy says

    A little late to this… Great article. I was caught with a large TDF 2020 in taxable account and have a surprise tax bill due to the capital gain.

    In the past have also sat on the committee overseeing my old company’s 401k, which used Vanguard exclusively. Each year the Vanguard reps would come in and talk about the changes to the various funds. That committee had a fiduciary responsibility to the Company’s employees and, as such, would be almost required to move the the lower-priced fund if it was offered. Vanguard of course knew that was the anticipated result and the capital gains effect on remaining shareholders would be readily apparent to any first year employee.

    All that and the funds were merged after nine months. Wonder how many taxable accounts were affected.

    Almost worst of all is the silence from Vanguard. I called on January 3 and was told a completely different story. Took this article and others to shine the light on such utter incompetence. Wonder what fiduciary duties Vanguard had/bent to all shareholders by making this move.

  14. Jonathan— excellent analysis

    I got blindsided by Vanguard’s actions

    Have you heard of an class action law suits filed against Vanguard?

    Thanks again

    • Michael Anderson says

      I read somewhere today (Barrons?) that a lawsuit has been filed about this recently. If victorious and similar to other class-action rewards, in about 7 years you can expect something nearly worthless such as complimentary asset management for one year. Too bad the plaintiffs lawyers couldn’t be paid from the bonus of the Vanguard executive who approved this bonehead move.

  15. This sounds like Vanguard marketed/advertised a different target retirement vehicle to businesses whose employees were using VFORX, so when the businesses transferred out of (sold) VFORX to go instead into those other Target Retirement accounts, it tanked VFORX. This seems like a horrendous way to manage anything. Should ppl in VFORX not have been told that Vanguard was steering significant portions of the holders out of VFORX into something else? This is like being deliberately sabotaged. VFORX had a massive straight-line drop from 50 to 38 or something, and now has hovered there for months. Would we expect it to EVER recover? If Vanguard is steering customers to other target retirement vehicles, won’t VFORX just keep going down? I feel like I got screwed by Vanguard on purpose. Should I just realize this massive loss and get out before Vanguard advertises yet another alternative to their own VFORX?

  16. Holy hell this is pretty awful. This resulted in me getting $62k in unexpected capital gains, taxed at 33% total (I’m in CA) = ~$20k in extra taxes, plus the penalties I’m sure I’ll have to pay for owing so much. PLUS it pushes our income level too high to qualify for Roth IRAs, so I’ll have to recharacterize the funds contributed to both my wife’s and my Roth IRA accounts. AWESOME.

  17. I really appreciate your investigation and reporting Jonathan! Like a few others here, I also realized substantial gains in a taxable account. Fortunately, I was in a unique year of my life where I had next to zero income, so the net effect was I didn’t have to pay tax on the gains. I never like to count on luck, but I’ll take it when I get it!

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