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It’s easy to select a good asset allocation for your nest egg on your own, but if you don’t have the discipline to stay balanced, a target-date retirement fund could be your best option, says Money Magazine’s Walter Updegrave. Sign up for the Ask the Expert e-mail newsletter Question: I’ve got my 401(k) invested in a target-date retirement fund. I’m wondering, though, whether I would be better off investing it in large-cap, mid-cap, small-cap and blended funds, putting 25% into each option. What do you think? –J. Duffaut Answer: You’ve no doubt heard the expression, “First, do no harm.” (You scholarly types may be more familiar with the Latin version, “Primum non nocere.”) It’s a bedrock principle that all good physicians adhere to. The idea is that a doctor shouldn’t dole out medicine or prescribe a treatment that has an uncertain benefit for the patient but may have a good chance of causing harm. In other words, a doctor must consider the downside before intervening. Well, I think that individual investors - and particularly people who are building a nest egg for retirement in a 401(k) or similar account - ought to take this principle to heart as well. Take the case of 401(k)s and target-date retirement funds. The number of 401(k) plans offering target funds has mushroomed over the past few years and more and more participants are plowing their contributions into this option. I think the growing popularity of target funds is good for two reasons: 1. They make retirement investing easy. Just choose a target fund with a date that roughly matches the year you plan to retire, and you get a ready-made diversified portfolio of stocks and bonds that’s appropriate for someone your age. What’s more, the fund automatically shifts its mix more toward bonds as you age, so that you take less investing risk as you grow older. 2. They can save us from our own worst impulses. Here I’m talking about our tendency to chase hot funds and sectors, buy into inflated asset classes and pour too much money into company stock and other investments that may be risky but we don’t necessarily see as risky. In short, target funds make it harder for us to sabotage our own retirement planning efforts. Are target funds for you?
Are target funds perfect? Of course not. But if your 401(k) offers this option, then it seems to me that before you reject it in favor of other funds, you ought to ask yourself: Can I do better on my own? The answer may very well be yes. You don’t have to be an investing savant to put together a decent portfolio of stock and bond funds. But you do have to take responsibility for creating and maintaining a workable investment strategy - that is, deciding on a reasonable mix of stocks and bonds, choosing appropriate funds, monitoring their performance and then rebalancing your portfolio once a year. If you don’t know enough about investing to do this or you’re not willing to put in the fairly minimal time and effort needed to do it (or you know deep inside that you’ll probably give in to the urge to tinker often enough that you may undermine your efforts), then it seems to me that taking an active approach has the potential to do more harm than good. In which case, I’d say you’re better off with a target fund. Now, I don’t know you well enough to judge how capable or responsible an investor you are. But based on your question, my guess is that you’re probably a good candidate for a target fund. Why? Well, you talk about putting equal amounts of money in large-, mid- and small-cap funds. That means you’ve got twice as much money in mid-size and small stocks combined as you do in the big boys. (Let’s leave the “blended” funds aside since I’m not sure what kind of funds you mean.) But if you take a look at the percentage of total market value that large-, mid- and small-cap stocks actually account for in the stock market, you find that large stocks represent almost 75% of market value and mid- and small-caps combine for the other 25%. (You can see this for yourself by plugging the stock market ticker for Vanguard’s Total Stock Market Index fund—VTSMX—into the Instant X-Ray tool.) This means that investors as a whole have allocated about three times as much of their capital to large stocks than medium and small ones. You, on the other hand, are proposing to do pretty much the opposite by putting twice as much in the mid-size and small stocks. If you’re doing this because you believe you have insights that investors overall lack - in effect, you think they’ve made the wrong decision - then fine, maybe it makes sense to go so far against the grain. But if you don’t have insights or information the rest of the investing world doesn’t have, then I don’t see how you can justify divvying up your money as you’ve suggested. Either way, I can tell you that by piling so much into mid- and small-size stocks (and putting nothing in bonds, unless they’re in your “blended” category), you are creating a very volatile portfolio that, if nothing else, is virtually guaranteed to give you a white-knuckle ride. So I guess I would answer your question with one of my own - namely, how did you come up with that 25%-in-each-group strategy? And unless you have a very cogent reason for it, I’d say you’re better off sticking with your target-date fund. That’s not to say, however, that at some point in the future you can’t switch out of your target-date fund and into a portfolio of individual funds you’ve created. But for that to make sense, I think at the very least you would want to have read a few of our Money 101 lessons, starting with the basics of investing, then moving on to stocks, bonds, mutual funds, asset allocation and, of course, retirement planning. Until you do that, however, I say your first obligation is to do no harm, which means staying put in that target-date fund. Filed under Uncategorized
Posted by kpantelides 9:08 am 11 Comments
 | Add a comment SanJoseMike makes many good points about investing young and letting it work for you. As for timing the market or getting caught up in the media surronding our current situation, I would like to offer a quote from Warren Buffet which goes like this; “Be fearful when others are greedy and greedy when others are fearful.”. Meaning in this market of fear, there is a prime buying opportunity for those that have the funds to do so. It’s when the herd is moving in one direction that you should consider taking another route. Posted By Kirk, Suffolk VA : March 11, 2008 5:34 pm
The problem with target funds is they take you out of the market when you get closer to retirement and who knows what the market will be like in 20-30 years. What if the five years before your retirement the market s just recovering but your target fund is taking you out of the run up. Take a Saturday afternoon to research the basics of mutual funds and you will see that usinf index funds of different types are your best bet. Every year look at them and adjust. This is your future and to not spend some time learning about investing is setting you up for failure or possible hucksters. Posted By Chris, New York, NY : March 9, 2008 10:48 am
DON’T “OVER-MEDDLE” YOUR ALLOCATIONS One of the biggest problems with both young and some older investors, is the “tendency” to read all the horrible news about markets and allow the (liberal) Media to make decisions for you, by their constant harping that the sky is falling. If you take them seriously, they will cause you to pull out of the market at the worst possible times. All financial markets (even this latest housing market) are cyclical. This means that even our housing market will go back up again. The question is when. We cannot answer that question, nor how long the recession we are in will last. Target funds allow investors to distance themselves from the cacophony of media yelling at you that the financial world will END or already has. I’m “old enough” to have seen it all. The exact mix of the target fund you select is less important that just letting it do its job over a long period of time. Asset allocation can be tweeked periodically and should be. And I leave that up to experts managing my allocation program. I agree with Walter Updegrave. Select a good target fund, and as you get older, allocated a higher % amount for bonds or bond funds. Don’t worry so much about the exact allocation. If you just leave it alone more than “fiddle” with it, you will do better. All historical studies have pointed to that…and will continue to do so. Sanjosemike Posted By San Jose, CA : March 9, 2008 10:47 am
The problem with all the target-date funds I’ve looked into is that their asset allocations are VERY heavily tilted toward U.S. stocks. I don’t think that makes sense, when the U.S. represents only about a quarter of world GDP. To allocate 90% or so of your stock portfolio to a region that produces only a quarter of the world’s goods and services is a big a mistake as the 4×25% strategy Mr. Duffaut proposes. Posted By Dean, Wolf Hole, AZ : March 7, 2008 7:08 pm
Most of us don’t have the time or skills to model and re-model an asset allocation program consistently over the years. But even a poorly modeled one…say that is over-invested in bonds when the investor is young…is better than nothing. The real advantage of a well-maintained asset management plan is that it can be done fairly inexpensively, if you select one that is offered by a major brokerage. Many can also outfit your portfolio with ETF’s (Exchange-traded funds). These allow you to shift without having to pay high commissions. For most young investors, the best policy is to save, save, save and put those moneys into a low-cost asset management portfolio offered by a large investment house. Then, “fogetaboutit.” During Black-Monday, I didn’t even look at my holdings, which had dropped very severely. That was a good policy. Within a year, everything went WAY up and I was back in the money, and well ahead. I haven’t looked at my holdings now in several weeks. I know they are down. It is vital not to get “plugged into” allowing the News Media to manage your life and portfolio. Statistically, the best mix (for young people, and older people who don’t need their money very soon) is 70% stock funds and 30% bond funds. We are in a recession. All economies are cyclical. We need to be calm and wait it out, staying invested. The profits will go to those who do. They always do. sanjosemike Posted By San Jose, CA : March 7, 2008 9:44 am
Vanguards target dates are the exception to the rule. Most target date funds are still actively managed, therefore they charge more on average then a standard index fund. Usually in the range of .75% or so vice .20% average for an index. Additionally, markets have shown that the majority of managed funds fail to beat the index as well. Posted By Kirk, Suffolk, VA : March 7, 2008 8:09 am
Target date funds are mostly made up of various index funds; example Vanguard 2045. If all you do is index you might as well go with the target date and simplify the process. Posted By Aaron, Mechanicsburg PA : March 6, 2008 2:09 pm
He came up with the 25%, 25%, 25%, and 25% breakout from Dave Ramsey’s suggestions? Posted By Rick Hunter, San Antonio Tx : March 6, 2008 12:18 pm
What about an Index Plus Fund — are there, could there be Funds that take the S+P 500 and try to eliminate the 100 biggest losers keeping the best 400. Even if they were off by a little, they should still beat the market Posted By dave Oz, RI : March 6, 2008 11:37 am
Very sage advice for folks that are not interested in developing their own mix of funds and prefer the hands off approach. Personally, I prefer a solid mix of index funds due to the lower expenses involved. Posted By Kirk, Suffolk VA : March 6, 2008 10:57 am
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I’m debating the same question, but for a regular taxable account. I have done well buying a mix of funds under my own name, but I want to begin investing joint money with my new spouse. However, we are also saving for a home, so we only have a certain amount to invest a month. I’m leaning towards one Vanguard Target Fund because we can’t afford to buy 3+ separate funds due to the fund minimum requirements. It’s not ideal, but doing something is better than nothing. And you do get the diversification in one place.