Conventional wisdom tells us that one of the most important things to do as an investor is to adjust your portfolio as you get older and approach retirement. Ideally, your investments will become more conservative over time. In your younger years, the goal should be to grow your money with stocks. It may carry more risk, but it is often worth it and probably worth it.
As you get closer to retirement, you don’t want to stop trying to grow your money altogether, but you do want to shift your focus to keeping the money you’ve earned up to that point. This means reducing your holding in stocks and increasing your holding in bonds and cash. You don’t want too much of your savings in stocks that are too close to retirement because you don’t have a lot of time to bounce back from downturns in the market.
For some people, the last thing they want to do is reallocate their investments on their own. This is where the funds for the target date come into play. Funds for the target date are based on your anticipated retirement and automatically reallocate to become more conservative as you get closer to retirement. And while taking this hands-on approach may seem ideal, it comes at a high price.
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Funds for the target date are not cheap
Since target date funds reallocate your holdings for you, they are actively managed and are typically more expensive than index funds. According to Morning StarAccording to the Target Date Landscape report, the average spend ratio for funds with target date at the end of 2021 was 0.34%. This may not seem like much on paper, but over time it matters more than you can imagine.
We compare the difference in value between an expense ratio of 0.34% and an expense ratio of 0.17% on an account if you were to contribute $ 500 a month for 25 years, with an annual average of 8%.
|Monthly contribution||Expense report||Total account||Amount paid in commissions|
|$ 500||0.17%||$ 427,893||$ 10,742|
|$ 500||0.34%||$ 417,442||$ 21,193|
By simply cutting your fees in half – which is doable even if you own about four low-cost index funds – you’ve saved over $ 10,000 in fees over 25 years. If your returns were higher in that range, the fee gap would be even greater.
You can do it yourself
There are generally four types of index funds that you need for a well-rounded retirement portfolio: large cap, mid cap, small cap, and international. With these four, you cover all your bases: you get the stability of larger cap stocks and the upside potential of small cap stocks, along with non-US exposure.
Here are the rough allocations that you can use as a guideline, adjusting them accordingly to your age and risk tolerance,
30 years and younger
Wallet: Stocks (100%), bonds (0%), cash (0%)
Stock breakdown: Large cap (50%), mid cap (15%), small cap (15%), international (20%)
from the 1940s to the early 1950s
Wallet: Stocks (90%), bonds (10%), cash (0%)
Stock breakdown: Large cap (60%), mid cap (10%), small cap (10%), international (20%)
From the mid-1950s to retirement
Wallet: Stocks (50%), bonds (30%), cash (20%)
Stock breakdown: Large cap (70%), mid cap (5%), small cap (5%), international (20%)
Do what makes you comfortable
You may decide that you prefer to pay higher fees for target date funds instead of having to worry about reallocating your wallet yourself. That’s fine. There’s a reason target date funds exist and are becoming more and more popular – they do the job for a lot of people.
You don’t want to do anything that makes you uncomfortable, but you should also understand that it’s not as difficult or time-consuming as it might seem. If you’re dealing with your 401 (k), it’s as simple as changing a few percentages in your election. If you are dealing with a brokerage account, put your investments into one of four broad categories, see how much you have invested in each and adjust your new contributions accordingly to reach your ideal allocation.
With less than an hour every few years (and that’s pretty frequent too), you can do the same thing that a target date fund does and potentially save yourself thousands.
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