As you peruse through the investment options available in your 401k you might see a bunch that have years within their fund name for example Freedom Investments 2025, 2030, 2035, etc… These represent target date mutual funds, or in other words, mutual funds that are designed to balance your allocation to stocks and bonds based off your age or years until you retire. The idea is that you select the fund with the closest year to your retirement (usually done in 5-year increments) and then just set it an forget it as the funds will change its allocation to match your risk level throughout the years.
While this isn’t a terrible option on its face, we see a few problems. First, these funds are typically not too cost efficient. Many have expense rations over 0.5% and even approaching 1%. See here for why expense ratios are so important . You could do the work yourself, and it’s not that difficult. You can select a broad market index-based fund for your stock allocation, and a broad bond market mutual fund for your bond exposure. Re-balancing (checking that your ratio of stocks to bonds isn’t out of whack from your goal) does not have to be done so often, perhaps once a year, maybe less.
Secondly, who says they have it right? There is a common convention that says as someone gets closer to retirement, they should change their allocation from stocks to bonds. This isn’t necessarily wrong, but you may feel that you are OK with a larger share in equities or bonds and not necessarily agree with the allocation of the underlying fund. At a time with extremely low interest rates, you may not want 40% of your investment in bonds if you are nearing retirement.
So in short, you are paying “extra” to have someone decide for you what allocation to bonds and stocks is right for you when with a small amount of effort you can do it yourself and save thousands in fees. Of course, if you are just so lost, and want that security of having someone else make those decisions, that’s fine, just watch out for those fees.
