To build or not to build your own portfolio?

By Walter Updegrave, senior editor

(Money Magazine) -- Question: Our retirement savings plan at work now offers several target-date retirement funds. I'm about 20 years from retirement, and I'm wondering whether I should consider one of these funds or try to keep a diversified portfolio on my own? -- Michael P., Chillicothe, Ohio

Answer: The answer depends on how confident you feel about building a portfolio on your own.

Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

You don't have to be a financial whiz to do so. Basically, we're talking about creating a mix of stock and bond funds from the lineup of investments in your plan that makes sense given factors such as how much risk you're willing to take and how long you have to go until retirement.

The closer you are to calling it a career, and the more anxious you get seeing your account balance head south during market setbacks, the more you'll want to tilt that mix toward bonds. To come up with a specific stocks-bonds blend that makes sense for you, you've got several options.

The first is to check out the resources offered by your plan. Most 401(k)s and similar plans provide online tools and calculators that can show you how different investment strategies might affect the account balance you accumulate during your career, as well as what that might mean in terms of future retirement income.

Some of these tools are getting quite good. As I noted recently, the Lifetime Income Analysis calculator that Putnam recently introduced does a particularly good job of showing people where they stand and what they can do to improve their retirement prospects.

If your plan doesn't offer such tools, a number of free calculators online, including our Retirement Planner, Fidelity's myPlan Retirement Quick Check, and T. Rowe Price's Retirement Income Calculator can demonstrate how different investment approaches combined with different levels of saving can affect your projected standard of living in retirement.

But if the thought of consulting calculators and such turns you off -- or you're just not sure that for now at least you want your retirement riding on your portfolio-building prowess -- then a target-date retirement fund is certainly worth considering.

The virtue of these funds is that they give you quick and easy access to a diversified portfolio. Just pick the fund with a target date that roughly corresponds to the year you think you'll retire and you'll get a pre-built portfolio that takes your planned retirement date into account when setting its mix of investments. Typically, the fund includes domestic and foreign stocks and bonds, and in many cases, target funds include some sort of exposure to inflation-hedges such as TIPS, real estate, commodities or natural resource stocks. The fund's mix automatically becomes more conservative -- i.e., shifts more assets away from stocks -- as you get closer to your retirement date.

But any "quick and easy" solution necessarily comes with drawbacks, the biggest of which in this case is that that no fund designed to cater to thousands of people can come up with the ideal mix for each of its shareholders, even if they're likely to retire around the same time.

If you've got lots of assets outside your company plan and will also be collecting a traditional check-a-month pension, you may be willing to take more risk (and thus accept a higher percentage of stocks) than someone your age who is relying pretty much on his or her 401(k) alone. Conversely, you might prefer a more conservative portfolio if just happen to be more risk averse. The point is that target-date funds don't lend themselves to individualized solutions.

Nor are their portfolios standardized. The percentage of assets in stocks can vary pretty dramatically even among target-date funds geared toward people of the same age. This became an issue during the last downturn when some target-date fund shareholders on the verge of retirement suffered steep declines in their account values because their fund held upwards of 60% in stock.

In the wake of that incident, Congress, the Securities and Exchange Commission and the Department of Labor have been examining these funds with an eye toward addressing such limitations. What "fixes" they'll come up with is anyone's guess (although as I said in a previous column, I hope the answer isn't to have the feds effectively set portfolio mixes for target funds).

In the meantime, though, target date funds remain an increasingly popular choice among investors. And as the stock market has recovered, they've been doing pretty well on the performance front too.

All of which is to say that, yes, if you don't want to create your own portfolio, a target-date fund is a reasonable choice. That said, before you plow your savings into one, check to be sure you're okay with the fund's investment strategy, particularly the percentage of assets in stocks. Don't just assume that the target fund your plan offers is right for you. While you're at it, make sure you also understand the fund's "glide path" -- how the fund's stocks-bond mix changes as you near and enter retirement.

Finally, there is one other thing you might want to consider if your plan offers it: a managed account. Essentially, you turn over management of your account to an independent investment firm that creates and monitors a portfolio based on your particular needs. This service isn't free, of course. So even if it's available and appeals to you, you'll want to ascertain that the managed account fee plus other plan charges aren't eating too deeply into your returns.

So take some time and think about which of these options realistically makes the most sense for you. But don't obsess too much. One of the nice things about investing within a tax-advantaged retirement account is that you can always change your mind later without having to worry that rejiggering your investments will be a taxable event.

Correction: An earlier version of this article misidentified the investment choice for those nearing retirement as stocks. Those investors should tilt the mix toward bonds. To top of page

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