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Personal Finance > Retirement

Recipes for retirement
You need to adjust your asset allocation as you get older. Why not just let a fund do it for you?
September 26, 2004: 6:41 AM EDT
By Walter Updegrave, MONEY Magazine

NEW YORK (MONEY Magazine) - If you feel overwhelmed by the dozens of different investing options out there for your 401(k), IRA and other retirement accounts -- or you have better things to do with your time than manage a retirement portfolio -- I have a suggestion that can make your life a lot easier and your investing strategy more effective.

My solution: Invest in a type of mutual fund known as a target-date retirement fund.

Although they're relative newcomers to the investing scene, target funds have been catching on big-time, with assets nearly tripling to $33 billion over the past 2 1/2 years.

Most of that tsunami of cash has come from 401(k)s; many plans are now using these funds as a default option for participants who don't specify how their contributions should be invested. But more and more investors are also choosing target funds for IRA rollovers and even for retirement assets held outside tax-advantaged plans.

How target plans work

First, you pick a fund with a date that roughly corresponds to the year you plan to retire. The funds are usually available in five- or 10-year increments from 2005 to 2050.

The fund then invests your retirement stash in a diversified blend of stocks, bonds and cash that has a risk/return profile appropriate for someone your age -- heavier in stocks if you're young, heavier in bonds and cash if you're older.

Hands-off investing
The asset mix in a target fund automatically shifts from stocks to bonds. Here's how that would play out for a 35-year-old who buys a target fund today and holds it into retirement.

Asset allocations

Investor ageStocksBondsCash
Notes: Allocations are for a hypothetical target fund. Actual stock-bond mix will vary depending on the fund company.
Source:MONEY research.

But here's the really neat part: Whatever asset mix the fund starts out with, it automatically shifts money from stocks into bonds and cash over time, so that the portfolio becomes more conservative and less volatile as you move toward retirement.

By the time you retire, the fund is mostly invested in bonds and cash with a modest stock position to provide some long-term growth (see the chart). All this takes place behind the scenes, however; all you have to do is sit back and enjoy the ride.

Saving you from yourself

I'm a big fan of these funds for two reasons. First, they make it incredibly easy for you to spread your retirement savings among a broad range of investments.

The second benefit is less obvious but to my mind just as important. By turning over your money to a fund that will follow a consistent, disciplined and diversified strategy, you're less likely to sabotage your retirement by making rash (and ultimately self-defeating) moves like jumping into tech stocks after they've had a big run-up. Or piling into bonds after stocks have taken a big hit but may actually be selling at attractive prices. In short, target funds can save you from yourself.

As much as I like these funds, they're not the no-brainers they're sometimes made out to be. While they are the same in concept, they don't all operate the same way.

So it's essential that you understand what you're getting and that it jibes with your investing style and risk tolerance. This is especially important if you're investing in a target fund through your 401(k), since you'll likely be limited to whichever company's target funds are offered in your plan.

The first thing you'll want to check is how the fund divvies up its assets. For example, Vanguard's 2005 fund, which is appropriate for investors on the verge of retirement, has 35 percent of its holdings in stocks and the rest in bonds. T. Rowe's Retirement 2005 fund stashes 61 percent of its assets in stocks.

Eventually both funds evolve into a more conservative mix of 20 percent stocks and 80 percent bonds and short-term investments. But Vanguard makes this transition in five to 10 years, while T. Rowe takes 30 years, which means you'd spend most of your retirement invested much more heavily in stocks.

T. Rowe's mix undoubtedly gives you a shot at higher long-term returns, but that opportunity comes with a risk: A bear market could maul your portfolio's value, leaving you less money than you'd have with Vanguard's more conservative blend.

Neither allocation is "better." It's a choice between facing the larger potential setbacks of a more stock-heavy mix or living on what will likely be the lower long-term return of a greater reliance on bonds.

You'll also want to know what the fund actually invests in. Fidelity Freedom funds, for example, invest exclusively in actively managed Fidelity mutual funds. Vanguard, not surprisingly, limits itself to the company's stable of index funds.

T. Rowe Price uses a combination of its S&P 500 index fund and its actively managed funds, while the Barclays LifePath funds track standard benchmarks but attempt to juice returns through quantitative techniques.

Again, it's a matter of trade-offs -- the certainty of getting market returns with indexes vs. the opportunity to do better (or worse) with active management.

The expense gap

But perhaps the biggest difference among these funds is expenses, which, to my mind at least, matter a lot, since every dollar in expenses reduces a fund's gross return.

Vanguard, as you'd expect, comes in with the tiniest fees, with no fund charging more than a razor-thin 0.23 percent a year. (TIAA-CREF's target funds, due out in November, could challenge Vanguard for skinflint bragging rights.)

The tabs for Fidelity's and T. Rowe's funds are substantially higher -- hardly earth-shattering news since they invest in actively managed funds -- but they're still reasonable, in most cases well below 1 percent.

Some target funds, however, stick investors with much heftier levies. Barclays Global Investors' LifePath funds weigh in with a 1.1 percent annual fee. And investors in Wells Fargo Outlook funds can shell out as much as 2 percent a year.

Comparing target funds
Asset allocations, expenses and underlying investments can vary dramatically depending on which target fund you choose. As this comparison of large retail funds designed for an investor in his or her late forties to early fifties shows, Vanguard offers the most conservative mix and the lowest expenses.
FundAsset mixAnnual expenses
T. Rowe Price Retirement 202080% stocks0.81%
20% bonds
Fidelity Freedom 202072% stocks0.87% [1]
28% bonds
Barclays LifePath 202066% stocks1.1% [2]
34% bonds
Wells Fargo Outlook 202066% stocks1.25% [2] or 2% [3]
34% bonds
Vanguard Target Retirement 202560% stocks0.23%
40% bonds
Notes:[1] Reflects an expense waiver of 0.02%. [2] Reflects an expense waiver of 0.34%; LifePath funds in a 401(k) would have expenses of 0.85%, which also reflects a waiver of 0.34%. [3] Expenses vary depending on share class of fund and reflect a waiver of 0.02% or 0.03%; Outlook shares in a 401(k) would have expenses of 0.95%.
Source:The funds.

Mercifully, both companies dial down the fees on target funds in 401(k) plans. At Wells Fargo, at least, those higher expenses are supposed to compensate a salesperson who's providing advice. But how much effort does it take to recommend a fund like this? And once you own it, the fund, not the broker, does all the work.

Unfortunately, you have no say over which target funds are available in your 401(k). You do, however, have some control over the asset mix.

Let's say you intend to retire in 15 years, but you feel the 2020 fund is too stock-heavy. You could opt for a 2015 or 2010 fund, which would lean more toward bonds. Or if you prefer a higher-octane mix, you could go for a 2030 or 2040 fund.

But if you're investing for retirement outside a company plan, I strongly advise you to shop around and, in particular, to consider the fees.

Once you've done that, aside from occasional monitoring, you can sit back and relax -- and spend your time thinking about more important things, like how you're going to enjoy retirement.

Senior editor Walter Updegrave is the author of "We're Not in Kansas Anymore" (Crown). You can reach him at To learn more about investing strategies, check out Ask the Expert, Updegrave's online column.  Top of page

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