Why are Vanguard's 2050 and beyond target retirement date funds badly underperforming the S&P?

Question

At work, we're in the process from switching from an IRA to a 401(k) and I've been looking at the different fund options.

What struck me as very strange was how poorly the Vanguard Target Retirement Date funds even for targets 25-40 years in the future have performed over the last several years vs. the stock market overall.

Comparing performance of their 2050 target date fund (VFIFX) vs. the S&P 500 (.INX) over different date ranges, I get these results:

Past year:
VFIFX: + 19.39%
.INX: + 25.65%

Past 5 years:
VFIFX: + 35.73%
.INX: + 60.44%

Since Jun 2006 (beginning of Google Finance's data for the comparison):
VFIFX: + 100.15%
.INX: + 158.88%

While I would totally understand a target, say, 2030 or 2035 fund having results of this nature, this seems odd to me for a target 2050 fund (and even the target 2060 results appeared to be very similar.)

Why would a fund targeting retirement 30+ years out have such poor results vs. the S&P 500?

Are the funds targeting that far out really that conservative vs. the stock markets overall? Or is this more just a result of the target funds having more global investments during a time when the U.S. stock market has been performing much more strongly than those of, say, the BRIC nations? Or something else I'm missing?

Answer 1

As @BenVoigt alluded to in the comments, you need to look at the portfolio for the fund in question. VFIFX specifically has the following breakdown of funds:

Total US Stock Market (VTSMX) - 54.4%
Total International Stock (VGTSX) - 35.6%
US and International Bonds - 10%

The 10% allocation to bonds would cause a slight lag in the growth of VFIFX compared to the S&P 500.

But, the more significant factor is the allocation to international stocks. Slightly more than a third of the fund is invested outside the United States. International stocks have had quite the ride over the past year due to trade wars and the like. VGTSX in particular has nowhere near the growth of the S&P 500 over the past several years.

You should also note that VTSMX is a Total Stock Market fund. This means it would contain many small and mid-cap companies not included in the S&P 500. While some of these may have beat the S&P 500, many of them probably did not.

The bonds, extra small/mid-cap companies included, and the large amount of international stocks have all done worse than the S&P 500 index, so it's no wonder that the fund itself is not doing as well either.

Why is it set up that way?

For diversification. You can justify the decreased gains by also having a decrease in risk through exposure to smaller cap US stocks and international stocks. Some people don't mind, others want growth closer to the S&P 500. But of course that extra growth comes with more exposure to large-cap US-only stocks. Whether or not it's worth the risk is up to the individual investor.