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A Retirement Portfolio You Can Set and Forget

Target-date mutual funds, also known as lifecycle funds, sound like the perfect choice for a time-strapped investor, a kind of "set it and forget it" solution to the problem of retirement portfolios.

What could be easier? You choose the fund closest to the year you plan to retire, hand them your money, and a fund manager somewhere does all of the asset allocation and rebalancing necessary -- and they'll keep on doing it, right up to and past your retirement.

But although the theory is the same -- a higher concentration of stocks when you're farther away from retirement, and a higher concentration of bonds when you're closer to retirement -- different funds allocate money differently. And that means varying returns -- and risks -- for you.

All target-date funds are not alike
Take a look at the different ways these three fund families allocate assets:

Fidelity Freedom Funds

Stocks

Bonds

2010

51%

44%

2015

56%

41%

2020

68%

32%

2025

71%

29%

2030

81%

19%

2035

83%

17%

2040

85%

15%

2045

86%

14%

Source: Fidelity, as of April 30, 2008. Excludes cash and short-term funds.

Vanguard Target Retirement Funds

Stocks

Bonds

2010

54%

46%

2015

63%

37%

2020

71%

29%

2025

78%

22%

2030

86%

14%

2035

90%

10%

2040

90%

10%

2045

90%

10%

Source: Vanguard, as of April 30, 2008. Excludes cash and short-term funds.

T. Rowe Price Retirement Fund

Stocks

Bonds

2010

59%

35%

2015

67%

27%

2020

75%

20%

2025

82%

15%

2030

87%

10%

2035

89%

7%

2040

89%

7%

2045

89%

7%

Source: Morningstar, as of March 31, 2008. Excludes cash and short-term funds.

The differences here aren't large, but over 40 years, they add up. Using the historical averages for stocks and bonds, I estimated what a $10,000 investment might return in these fund families over 40 years, assuming their allocations remain roughly the same:

Fund Family

40-Year Return on $10,000

T. Rowe Price Retirement Fund

$263,513

Fidelity Freedom Funds

$358,170

Vanguard Target Retirement Funds

$446,645

Those small differences add up to a 70% variance -- and that's a lot come retirement. Of course, the more aggressive allocation also opens you up to greater risk -- and you never know what the market will be like on the eve of your retirement.

But if buying a target-date fund includes having to research different allocation strategies and run simulations to figure out which one might best balance risk and returns for your particular situation, well, so much for set it and forget it.

Build your own!
Since finding a good target-date fund is more difficult than it seems, why not create your own? Our own Robert Brokamp, advisor to our Rule Your Retirement investment service, suggests the following asset-allocation model:

Conservative

Moderate

Aggressive

Large-cap stocks

20%

35%

50%

Small-cap stocks

5%

10%

15%

Foreign stocks

5%

5%

10%

Bonds

60%

40%

20%

REITs

10%

10%

5%

Choosing well-run, no-load mutual funds or index funds will give you ample diversification while simplifying the tracking and rebalancing of your portfolio. Take a look at these possibilities for further research:

Fund/ETF

5-Year Annualized Return

Significant Holdings

Large-Cap Stocks

T. Rowe Price Equity Income (PRFDX)

8.4%

Microsoft (NASDAQ:MSFT), Johnson & Johnson (NYSE:JNJ), 3M (NYSE:MMM)

Small-Cap Stocks

Third Avenue Small-Cap Value (TASCX)

14.7%

Brookfield Asset Management (NYSE:BAM), K-Swiss (NASDAQ:KSWS)

International Stocks

Dodge & Cox International (DODFX)

22.1%

Novartis (NYSE:NVS), Honda (NYSE:HMC)

REITs

DJ Wilshire REIT ETF (RWR)

14.9%

Simon Property Group, Boston Properties

Bonds

Managers Fremont Bond (MBDFX)

4.2%

U.S. Treasuries, U.S. Corporate Bonds

Data from Morningstar.

Rebalancing your portfolio annually -- and then only if asset classes are 10% or more away from where you want them to be -- will help ensure that you're achieving the balance of risk and reward you want for your portfolio.

The Foolish bottom line
Target-date mutual funds can be convenient, but like many conveniences, they may cost you.

If striking out entirely on your own is too daunting, consider the Rule Your Retirement investment service. You'll have access to all back issues, model portfolios, and the support of other subscribers on our boards.

You can try the service free of charge for 30 days -- with no obligation to subscribe. Click here for more details.

Julie Clarenbach does not own any of the stocks mentioned. Dodge & Cox International is a Motley Fool Champion Funds recommendation. Microsoft and 3M are Inside Value selections. Johnson & Johnson is an Income Investor choice. Brookfield Asset Management is a Global Gains pick. The Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (21)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 16, 2008, at 10:11 AM, Zelkurtis wrote:

    Excellent article however, the point of these funds is for the average 401k or IRA participant to get diversified instead of stuffing their money into the Money Market Mattress. Being in the 401k consulting business this is a God send for the person that has no knowledge or interest in gaining financial knowledge. Since Social Security will be negligible and pensions are going the way of Dodo (none too soon IMHO: a pension is a promise to pay money in the future as opposed to hard cash somewhere), at least the average person has a time sensative fighting chance with these funds.

    Are these for us Fools? Heck no! The mere fact you read a site like this over a fantasy football site proves that with an inch or two of effort you can do this yourself.

  • Report this Comment On June 16, 2008, at 3:19 PM, SMAasen100 wrote:

    I am curious as to the distribution of the $10k in each of the fund families which was used to prepare the 40yr estimated returns.

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