When you’re setting up your investment options in your 401(k), you’re typically given three main options: your employer’s stock (if it’s a public company), funds held together by market cap, And target date fund, Target-date funds are investments that meet your projected retirement year. As you get closer to the target date, the fund automatically changes its holdings to become more conservative.
Target-date funds have grown in popularity over the years. In 2021, the total amount invested in target-date funds hit a record $3.27 trillion (up 20% from 2020) morning StarThe Target-Date Strategy Landscape Report. Target-date funds can be a good option for investors looking to shake hands with their portfolio, but they come with a price.
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Since they reallocate your holdings for you, target-date funds tend to be expensive compared to other index fund options. It’s Not That Far Away To Find A Target-Date Fund expense ratio Around 0.50%, which means it will cost you $5 for every $1,000 you invest. While this may not sound like much, it can add up to thousands in fees paid over the life of the 401(k).
weed out the middleman
Target-date funds have four main types of assets: US stocks, international stocks, bonds, and cash. As for stocks, most target-date funds are “funds of funds,” meaning they contain other, usually much cheaper, funds. Instead of paying the expensive fees that often come with target-date funds, you can remove the middleman and invest in target-date funds. For a good, well-rounded retirement stock portfolio, you only need four types of funds: large-cap, mid-cap, small-cap and international.
Large-cap funds tend to have larger companies that are generally more stable because they have more resources for their profits. You probably won’t see extraordinary growth from large-cap funds because of their size, but they have proven to be more reliable over time. Small-cap funds are on the opposite end of the spectrum. They are smaller companies with high growth potential, but they are more prone to volatility and less likely to make it through rough economic times. Mid-cap funds represent a good niche: small enough for high growth but large enough to take on low risk.
International funds include non-US companies and should be part of anyone’s portfolio. If you’re only investing in US companies, you’re limiting your return potential and you’re not as diversified as you should be. A good rule of thumb is to have about 20% of your portfolio in international stocks.
Handle your own stock reallocation
It is important in investing to adjust your portfolio risk profile according to your age. You don’t want to risk too much close to retirement in case something goes wrong (like a bear market), and you end up unable to recover financially. In your younger years, the majority (if not all) of your portfolio will be in stocks. As you near retirement, your portfolio will start to include safe assets like bonds and cash.
Fortunately, you don’t have to pay high fees to have target-date funds to reallocate for you; You can do it yourself. For someone in their 20s or 30s, you can take on more risk, so your allocation could be 80% to 90% in stocks with allocations like:
- Large-cap: 50%
- Mid-cap: 15%
- Small-cap: 15%
- International: 20%
If you’re in your 40s, you have about two decades before retirement, so you don’t have to be too conservative right now. Your allocation may be 30% to 40% bonds and the remaining allocation of stocks can be divided as follows:
- Large-cap: 60%
- Mid-cap: 10%
- Small-cap: 10%
- International: 20%
As you enter your 50s and your final decade before retirement, you’ll want your large-cap stock to lead the way. You still want to grow your money, but you also want stocks that are generally more stable and can help preserve what you’ve built, at least up to that point. Your portfolio might be split between 40% to 50% bonds, 10% cash, and the rest:
- Large-cap: 70%
- Mid-cap: 5%
- Small-cap: 5%
- International: 20%
There is no one-size-fits-all approach when it comes to your allocation. You can start with these baselines, but it is important to adjust them based on your individual situation and risk tolerance. You may be in your 30s and decide that you are risk averse and prefer very little exposure to small-cap stocks, or you may be in your 50s and have more risk in your portfolio. One may be comfortable with high-reward stocks.
Whatever it is, do what makes you feel comfortable. By taking just a few minutes each year to adjust your allocation, you could potentially save yourself thousands over time.
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