We're certain that you're smart and capable (not to mention good-looking), and so we're confident that you're the best person to make your own investment decisions. As such, we're not always fans of mutual funds that make your investment decisions for you, based on your target retirement date.
These funds can sometimes be too conservative, too racy, too costly, or too simplistic for your needs. However, that doesn't mean it's never a good idea to put your 401(k) savings into a target retirement fund. Here are three reasons to take aim.
Your 401(k) stinks
When you're stuck with a truly dismal 401(k) plan, a target retirement fund might bail you out of a bad situation. Consider investing in one if your other options consist only of expensive, underperforming mutual funds. Many target funds come from low-cost mutual fund companies, so they may be less pricey than your other options. Some also consist of a variety of index funds, letting you at least match the performance of the market.
That's not always true, though, so don't dive in until you've looked closely at the target retirement fund's expenses and its underlying investments. If they look acceptable -- even if they're not ideal -- you'll probably end up better off in the long run.
Typically, you can't get started saving money in your 401(k) plan until you sign up and choose your investments. That can be a hurdle for anyone who needs to find a few spare hours to sift through reams of prospectuses, and who has a few spare hours lying around? (If you do, send a few my way.)
If you're sitting on the sidelines, a target retirement fund will get you started, and that's the biggest key to a happy retirement. By not saving at all, you're giving up the opportunity to get the power of compounding interest working for you. You might also be leaving free money on the table. Invest enough to maximize your employer's matching contribution, and then block out some time to delve into your other options.
You've come to the right place to study up on retirement planning, but you're not going to master every nuance overnight. While you're constructing your own plan, a target retirement fund can be a pretty good place to stash your money. It certainly beats a money market fund.
A target retirement fund will typically put some of your money to work in stocks, both domestic and international. It will also allocate a portion to something safer, like bonds. That basic formula buys you some time to figure out how you want to invest your money.
You can also use a target retirement fund as a template to start formulating your own investing philosophy. If you're a 45-year-old with plans to retire in 20 years, for example, you can start by comparing different approaches to asset allocation by looking at three of the biggest funds targeted to your retirement date.
At the more conservative end of the spectrum, you'll find Fidelity's Freedom Fund 2030 (FUND: FFFEX ) putting 80% of its money in stocks and 20% in bonds. In the middle, Vanguard's Target Retirement 2030 (FUND: VTHRX ) allocates 86% to stocks and 14% to bonds. More aggressively, T. Rowe Price's Retirement 2030 Fund (FUND: TRRCX ) puts 91% in stocks and 9% in bonds.
All three companies build these target retirement funds with in-house mutual funds, and anchor them with a large-cap equity fund, but they're not all alike in that respect, either. Digging into the details of these funds reveals some interesting differences.
Vanguard, as you might expect, gives an index fund the top slot. Its Total Stock Market Index fund (FUND: VTSMX ) sops up 69% of the fund's holdings, with ExxonMobil (NYSE: XOM ) as its top stock. T. Rowe Price makes its Growth Stock (FUND: PRGFX ) fund the biggest player, holding General Electric (NYSE: GE ) and Google (Nasdaq: GOOG ) in its top positions. The Fidelity Disciplined Equity Fund (FUND: FDEQX ) , where Hewlett-Packard (NYSE: HPQ ) , ConocoPhillips (NYSE: COP ) , and JPMorgan Chase (NYSE: JPM ) are among the top holdings, leads that company's target fund.
Of course, asset allocation's just one aspect of retirement planning. Keep reading to learn the Fool's four rules of asset allocation, and: