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The Right Way to Target Your Retirement

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When you're still learning how to invest, the idea of putting everything you own into a single, simple mutual fund may sound like the perfect solution. Increasingly, though, investors have found that target date mutual funds are far from perfect. Fortunately, even if target funds won't get the job done, it's easy for you to take control of your own retirement investing while ensuring that you won't get any nasty unexpected surprises.

Where's the target?
The target fund concept couldn't seem easier: If you know when you want to retire, just find the fund that matches up with the year of your retirement. Then, your fund's managers will figure out which mix of stocks, bonds, and other investments will earn you the most money while keeping risk levels under control. Over time, the fund will slowly change the way it invests as you approach retirement, and the closer you get to the fund's target date, the more conservative you can expect its investments to become.

That's a simple concept, but in practice, it turns out it's a lot more complicated. What many investors discovered during the bear market of 2008 and early 2009 was that their target funds held much more of their money in stocks than seemed appropriate, especially for those funds designed for people within a few years of retiring. Even some 2010 target funds turned out to have 50% or more of their assets invested in stocks, and those funds dropped like a stone during the market meltdown. Criticism from investors and the Securities and Exchange Commission led fund companies Charles Schwab (NYSE: SCHW  ) and the OppenheimerFunds unit of Oppenheimer Holdings (NYSE: OPY  ) to reduce the amount of stock held by target funds.

Moving way beyond simple
But the steps some funds have taken go well beyond simply reining in stock allocations. They're also making the funds a lot more complicated. According to The Wall Street Journal, T. Rowe Price (Nasdaq: TROW  ) and Principal Financial (NYSE: PFG  ) have broadened their target funds to own not just stocks and bonds but also commodities and real estate. ING (NYSE: ING  ) plans to use hedge-fund-style investments with a small portion of investors' portfolios.

Investors may also find that what their fund happens to own today isn't necessarily how it will invest their money tomorrow. AllianceBernstein (NYSE: AB  ) , for instance, reserves the right to reduce stock allocations by as much as 20 percentage points to respond to adverse market conditions. On the contrary, UBS (NYSE: UBS  ) uses leverage to ramp up risk levels on investments that might otherwise be too conservative for young or other aggressive investors to include in their portfolios.

The better way
When you can't count on a fund company to do what you want it to do, it's time to take matters into your own hands. Fortunately, with the help of mutual funds and exchange-traded funds, it could hardly be easier to come up with a do-it-yourself target fund.

The first step is to determine an appropriate asset allocation for right now. If you have decades before you plan to retire, then a more aggressive mix of investments focusing on stocks with a mix of commodities and real estate investments has a good chance of producing the best returns. If you're closer to retirement, mix in more fixed-income investments like bonds.

Next, decide what you want your retirement portfolio to look like. The answer depends on how much money you expect to have compared to your desired lifestyle. If you'll have ample money, then you can afford to be completely safe; if you'll need further growth, then plan to keep a portion of your money in stocks and other riskier investments.

Finally, plot a course to get you from now to retirement. For instance, say you have 20 years before you want to retire. You decide to invest 80% in individual stocks and stock ETFs and 20% in bond ETFs now, with the plan to be 100% invested in fixed-income by the time you retire. The simple move is to reduce your stock allocation by 4 percentage points per year when you rebalance your portfolio. With several brokers offering commission-free investments in ETFs, such rebalancing is both convenient and inexpensive.

Take control
Sure, the do-it-yourself target fund takes more work than a managed fund would. But when you take care of it yourself, you know it's being done right -- and you never have to worry what kind of risk some Wall Street wonk is taking with your money.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Fool contributor Dan Caplinger seems to hit Target nearly every weekend. He doesn't own shares of the companies mentioned. Charles Schwab is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletters today, free for 30 days. Don't get in the way of the Fool's disclosure policy when it has a dart in its hand.


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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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