Being too hands-off can be costly.
Everyone’s risk tolerance is different, but traditional investing wisdom tells us that the younger someone is, the more risk they can take in the stock market. When you’re younger, your focus should be on growing your money as much as possible, which generally means investing in stocks. As you get older, your focus should slowly but surely switch to preserving the money you’ve made up to that point.
Target-date funds are exchange-traded funds (ETFs) based on your projected retirement year. As you get closer to the target date, the fund automatically rebalances itself to become more conservative, meaning it’ll begin to hold fewer stocks and more bonds and cash. Target-date funds can be a great option for investors who prefer to be hands-off, but they can come with a hefty price tag.
Luckily, with a little bit of time every few years, you can save yourself thousands. Image source: Getty Images. You have to pay for convenience
Since target-date funds are actively managed and reallocate their holdings for you, they’re usually more expensive than index funds. It’s not uncommon to find a target-date fund in the 0.50% expense ratio range (meaning you’ll pay $5 for every $1,000 invested), and although this percentage may look small by itself, it adds up over time.
Let’s compare the difference in value between a 0.50% expense ratio and a 0.25% expense ratio on an account if you were to contribute $500 monthly for 25 years, averaging 8% annual returns.
Data source: author calculations.
By lowering fees by 0.25% (which is very doable), you could save over $15,000 over 25 years. And that’s with a modest 8% growth; if you averaged higher returns, the amount saved would be more. No need for the middleman
There are three main types of assets in a target-date fund: stocks (U.S. and international), bonds, and cash. Stock-wise, target-date funds are “funds of funds,” meaning they consist of various (usually much cheaper) funds. By investing in the type of index funds that target-date funds would hold, you can cut out the middleman and save money.
Investors can generally do this with four types of index funds: large-cap, mid-cap, small-cap, and international. Adjusting with age
Your portfolio’s allocation should largely depend on your age and risk tolerance. Here are some examples of how someone may break down their portfolio based on their age. Younger than 40
Someone in their 20s and 30s can afford to take on more risk because they have a lot more time to recover from bad investments or down periods in the stock market. In this age range, a portfolio could be all stocks broken down as follows: Large-cap: 50%
40s to early 50s
In this age range, you don’t have to become too conservative just yet. You may not have all your portfolio in stocks, but most of it should be. A range between 80% to 90% in stocks and the rest in bonds would be a good baseline, with the stocks broken down like: Large-cap: 60%
Small-cap: 10% International: 20% 50s to retirement This is the age range where you want to become more serious about preserving the money you’ve made through your career. It doesn’t mean abandoning stocks, but it does mean adding more bonds and cash. A potential breakdown of around 50% in stocks, 30% in bonds, and 20% in cash could work, with the stocks as follows: Large-cap: 70% Mid-cap: 5% Small-cap: 5% International: 20% Only you know your risk tolerance Some people may decide that no matter how much they’d save, they’d rather be hands-off and use target-date funds, which is perfectly fine. Every approach doesn’t work for every investor. But for those who would like to potentially save thousands but are unsure if they have the time to reallocate their portfolio, know it’s not complicated or too time-consuming.All you have to do in your 401(k) is adjust the percentages of investment elections. In your brokerage account, it can be as simple as seeing how much you have invested in the four categories (large-cap, mid-cap, small-cap, and international) and adjusting your new contributions accordingly to get to your target allocation.The most important thing is to do what makes you comfortable. These percentages aren’t universal, but they’re a good baseline that you can adjust to your particular risk tolerance and financial situation. Something big just happened When our award-winning analyst team has an investing tip, it can pay to listen. After all, the […]
Being too hands-off can be costly.