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Do you know what box you checked when you signed up for your 401k or 403b or 529 plan? Pick something that sounded good, like “fixed income” or “cash max” or whatever? Guess what?
Wrong. You should give some serious thought to how you’re allocating that retirement fund, because for many people it will be the biggest investment you’ll ever make, except for your house, and we all know there have been a few problems with that investment, no?
Many of these plans have a terrible set of choices. I don’t know how employees let companies get away with offering them only Lord Putheimer funds or some other combo crap of high commission, low performance load mutual funds. I mean, pick up any newspaper and you’ll see an infinite number of recommendations to avoid these turkeys. But then, nobody reads anymore. If this describes the offerings of your company, it’s time to start “encouraging” a better choice of funds. It’s your money and your future, not the company’s.
But, let’s say your 401-403-529 does indeed offer some decent companies—Fidelity maybe, or T. Rowe Price, or if you’re really working at the right place, maybe they’ll even offer Vanguard. Should you pick the Target Date fund that most closely resembles when you hope to retire (or when your kid starts college), or should you hand pick specific funds? Here’s what you should consider:
- What’s in the proposed fund? What mix of stocks, bonds, and other investments does it offer? Mostly active funds or passive funds? Are you comfortable with 90% stocks, or would you sleep better with a 60/40 mix? You have to be comfortable with the risk, no matter what your actual age. On the other hand, I see many young people who watched their parents’ retirement funds evaporate and are more conservative than is reasonable.
- How much money do you have in it? If you are just starting out, investing in something diversified is important, and maybe difficult to achieve with a small amount of money. However, if there are six figures in that account, you may want to choose, or get help choosing your own diversification.
- How much time and knowledge do you have? Will you take the time to compare the target fund’s results to your own proposed portfolio selection? This can be difficult because many target funds don’t have a really long track record. Of course, historical performance is no guarantee of future results, but what else do we have?
- Is there a management premium? Check out how management fees are charged—does the fund charge an extra management fee on top of all the management fees in the individual funds? Is it reasonable? Could you invest in a reasonable selection of stock/bond/alternative funds individually for less total management costs? Ask for a Morningstar sheet on the target date fund and take a look at it compared to individual funds (individual bond funds and stock funds should be very low; international funds somewhat higher). Note that management fees are different from commissions or loads—management fees are what keep the lights on at Fidelity, Vanguard or whatever. They are deducted from the return you actually see deposited in your account. You’ll never actually see them, except as to how they affect your returns. Which can be a lot of leakage, depending on the fund and the fund company—another reason for passively managed funds with no “star” managers.
- How does it fit in with the rest of your portfolio? If you have a “rest of…” that is. It is quite difficult to do an accurate asset allocation profile with a target date fund in the mix. As an estimate, you or your financial planner can break the fund into percent categories, but it’s not easy. Also, if you have significant investment assets, you should be considering asset “location” as well—things that generate interest in non-tax accounts, things that generate capital gains in taxable accounts, internationals in taxable accounts, as a ROUGH guide—your own investment picture may vary. Target date funds give you less control.
Now, don’t use any of this as an excuse to stop contributing. If you get an employer match, you’ve probably already gotten a better “return” than the market is offering. Then, there’s the tax benefit of salary reduction. As with all wealth building, first HOLD ON to your money, then figure out the best way to invest. If your 401k forces you to save, that may be the best investment of all.
