About 85% of 401(k) retirement plans offer target-date funds, according to the Employee Benefit Research Institute and the United States Government Accountability Office. These professionally managed portfolios of stocks and bonds slowly grow more conservative as you move closer to retirement. Problem: Millions of investors use these funds incorrectly, and that can lead to unanticipated performance outcomes and volatility. These funds offer broad diversification with thousands of underlying investments. But such a simple solution lacks personalization—you use the same product as investors who plan to retire around the same time, even if you have different risk tolerances and retirement needs. Result: You may try to tinker with your portfolio to improve it. If you are tempted to combine your target-date fund with other investments, consider the following strategies…
Use a target-date fund with a different retirement date if your goal is to have a more aggressive or conservative portfolio. Example: Just because you are retiring in 10 years doesn’t mean you must invest in the Vanguard Target Retirement 2035 (69% stocks, 31% bonds). Bolder investors can switch to the Vanguard Target Retirement 2040 fund (75% stocks, 25% bonds)…more cautious investors to the 2030 fund (closer to 60% stocks, 40% bonds). You even could split your assets, putting a portion in the 2035 fund and the rest in one of the others.
Limit the investments you hold in addition to your target-date fund to no more than 5% to 10% of your overall portfolio. That way you can satisfy investment urges and need for personalization without disturbing your long-term allocation too much.
