The promotional material for the new Vanguard Managed Payout Funds describes these offerings as a way "to receive payments in retirement without exhausting capital." They provide a simple strategy to eliminate the investor's need to rebalance investments and initiate withdrawals. To quote from the Vanguard website, these three funds:

• Automatically generate regular monthly payments that are set each year.
• Are actively managed by Vanguard with a focus on reducing volatility.
• Are designed to maintain (or grow) your investment.

      7% for the Vanguard Distribution Focus Fund (VPDFX)
      5% for the Vanguard Growth and Distribution Fund (VPGDX)
      3% for the Vanguard Growth Focus Fund (VPGFX)

However, Vanguard warns that these funds "are not guaranteed to achieve their investment objectives, are subject to loss, and some of their distributions may be treated in part as a return of capital." In other words, investors can't count on these payout percentages, and Vanguard might achieve its payout objective by returning their initial investment. So, the payouts could change and/or they could substantially shrink one's portfolio.

Payout Fund Asset Allocations
The planned holdings of the payout funds have been somewhat mysterious since they were announced last year. They are structured as "funds of funds," but Vanguard did not indicate the planned allocation percentages. Now that the funds have been launched, the Vanguard website is publishing this information. Here are the holdings as of 5/31/08:

Underlying Funds	VPDFX	VPGDX	VPGFX
Total Stock Market Index (VTSMX)	30.20%	33.40%	38.70%
European Stock Index (VEURX)	16.30%	17.70%	20.40%
Pacific Stock Index (VPACX)	7.20%	8.00%	9.10%
Emerging Markets Stock Index VEIEX)	6.30%	6.90%	7.90%
Market Neutral Fund (VMNIX)	9.90%	10.00%	9.90%
Other (see the 2nd wild card below)	5.20%	4.00%	4.00%
Total Bond Market Index (VBMFX)	19.90%	15.00%	10.00%
Inflation-Protected Securities (VIPSX)	5.00%	5.00%	-
TOTAL	100.00%	100.00%	100.00%

The first thing to note is that these funds are far more heavily weighted toward equities than the conventional retirement income funds.

• 75% equities for VPDFX (Distribution Focus)
• 80% equities for VPGDX (Growth and Distribution)
• 90% equities for VPGFX (Growth Focus)

Wild Card Holdings
There are two nontraditional "wild card" holdings which account for about 14%-15% of the payout portfolios:

1. A "Market Neutral" fund, which can invest long or short on any domestic stocks. This fund has been around since 1999, but it was only recently acquired by Vanguard. The fund can be purchased individually, but it has a minimum investment of $250,000 and charges an expense ratio of 2.00%.
   
   
2. An "Other" category consisting of equity-like investments "in commodities and in selected other investments that have historically generated long-term capital."

Some Concluding Thoughts
These funds mark an astonishing new direction for Vanguard, a company associated with fairly conservative strategies for investing during retirement. The funds probably owe their design in part to the influence of the hedge fund industry, which has relied heavily on commodities and long-short investment strategies. Even so, the funds only allocate about 15% in this direction.

Strong on Equities: All three funds, are far more weighted toward equities than the traditional 60:40 ratio of equities to fixed income commonly recommended with the 4% safe withdrawal strategy. Again, this is surprising for a historically conservative mutual fund company. Vanguard claims that the management of these funds will have a focus on reducing volatility, presumably from the inclusing of a 10% market neutral allocation. But will such high equities allocation, it's likely that customers will see considerable volatility. A 10% market neutral strategy and 4%-5% commodity allocation won't bring the volatility of these funds down to the level of old-style retirement income funds, which typically hava a 50% to 70% fixed-income allocation.

No Inflation Adjustment: The usual implementation of a safe withdrawal strategy assumes an annual cost of living adjustment. There is no comparable adjustment for the withdrawals from these funds. Increases in the annual payouts would be dependent on favorable market conditions that produce nest-egg growth above the withdrawal rate. Periods of high inflation and/or weak markets would inevitably mean a loss of purchasing power for the payouts from these funds. Of course, prolonged market rebounds and reduced inflation could reverse this situation.

Customer Understanding: A powerful selling point for these funds is their simplicity for retirees. They will therefore be especially appealing to unsophisticated investors. You get a fixed monthly payout set on an annual basis — no muss, no fuss, no rebalancing. But unsophisticated investors also tend to underestimate investment risk. They may not fully appreciate that the payout will change each year, higher or lower. They may significantly underestimate loss of purchasing power from inflation. And they may not take seriously the fine print warning that these funds do not guarantee an income stream for life.

A "Quickie" Risk Assessment: For a retiree with a 30-year planning horizon, the risk of depleting a nest egg invested in the 3% payout fund is very low. A 5% payout carries an increased risk. And the 7% would have a high risk of premature depletion over this timeframe. Thus, the Distribution Focus Fund with its high payout rate would be better suited to older retirees.

To repeat an earlier observation, the Vanguard's Managed Payout Funds are a new direction for this legendary company — one likely to attact inreasing attention as the Boomer generation enters retirement. It will be interesting to follow the fortunes of this bold new strategy.