Overindulgence in Laissez-Faire Approach Deteriorates Your Retirement Funds
In the world of retirement planning, understanding the various investment options available is crucial. One such option is the target-date fund, a popular choice among retirees and those nearing retirement.
Target-date funds consist of four main types of assets: U.S. stocks, international stocks, bonds, and cash. These funds are designed to cater to retirees based on their projected retirement year, automatically adjusting the allocation of these assets over time.
However, it's important to note that the average expense ratio for target-date funds generally ranges between about 0.45% and 0.50%, which is higher than many broad-market index funds. For instance, the MoA Clear Passage target-date funds show expense ratios around 0.46%-0.50%, while a low-cost institutional target-date fund from Dimensional has an expense ratio of about 0.16%.
Over the lifetime of a 401(k), fees from higher expense ratios can add up significantly. For example, if a 401(k) account grows to $1 million over 30-40 years, an expense ratio difference of around 0.30% (e.g., 0.50% minus 0.20%) can cost thousands of dollars due to fees paid every year on the growing balance. While exact dollar costs depend on investment performance and contribution levels, an often-cited estimate is that paying 0.30% more annually on $1 million could cost around $3,000 per year in fees, compounding to tens of thousands or more over decades.
Despite the relatively higher costs, target-date funds offer a managed, diversified portfolio that automatically adjusts asset allocation over time, which some investors find convenient. As one enters their 50s, the self-managed retirement portfolio may be 40% to 50% bonds, 10% cash. At this stage, large-cap funds may lead the way, making up around 70% of the portfolio, while mid-cap and small-cap stocks may constitute 5% each. International stocks may make up 20% of the portfolio for diversification and return potential.
For those who prefer a more hands-on approach, investing in the individual funds that the target-date fund holds can be an option. A good, well-rounded retirement stock portfolio requires four types of funds: large-cap, mid-cap, small-cap, and international. Large-cap funds consist of larger, more stable companies with less growth potential, while mid-cap funds offer a balance between high growth and reduced risk. Small-cap funds represent smaller, high-growth companies with more volatility and less resilience during economic downturns.
Regularly adjusting one's allocations in a self-managed retirement portfolio can potentially save thousands over time. Adjusting one's allocations based on personal situation and risk tolerance is important, especially as you get closer to retirement. This helps to avoid taking on excessive risk close to retirement.
In conclusion, while target-date funds offer a convenient, diversified portfolio, they come with higher fees compared to typical low-cost index funds. However, the decision between a target-date fund and individual funds ultimately depends on an investor's preference for convenience and the willingness to pay a premium for that convenience.
Sources:
- Investopedia
- Dimensional Fund Advisors
- Fidelity Investments
- Kiplinger
- Morningstar
- For those interested in personal-finance, understanding the costs associated with investing in target-date funds is crucial since the average expense ratio can range from about 0.45% to 0.50%, higher than many broad-market index funds.
- A key advantage of investing in target-date funds is the convenience of having a managed, diversified portfolio that automatically adjusts asset allocation over time, making it an attractive option for some retirees and those nearing retirement.
- In the realm of personal-finance, if an investor prefers a hands-on approach, they have the option to invest in the individual funds that the target-date fund holds, creating a well-rounded retirement stock portfolio consisting of large-cap, mid-cap, small-cap, and international funds.
