Your 401(k): Target Date Funds Disappoint

I can't say what the right portion of stocks is for every investor, but I can tell you that the classic balanced portfolio is 60 percent stocks and 40 percent bonds. A portfolio with more than 60 percent stocks is considered aggressive; less than 60 percent is moving into conservative territory.

If you're uncomfortable with stock allocation tied to your age range, then consider moving up or down the target date scale to adopt either a more conservative or a more aggressive approach.

For an appropriate guideline, you might want to consult the allocations used in the Lifecycle Funds offered through the Thrift Savings Plan, a well-regarded retirement savings plan offered to federal government workers. You find the allocation information at the Thrift Savings Plan web site: www.tsp.gov.

For instance, the Thrift Savings Plan's 2010 fund currently holds about 70 percent bonds and 30 percent stocks. It fared relatively well in the 2008 market crash, losing 10.5 percent for the year.

The second critical issue in examining target date fund choices is expenses. How much will the fund cost you to own? Higher expenses mean you accumulate less for retirement.

According to fund researcher Morningstar Inc., the average target fund expense ratio (on an asset-weighted basis, meaning bigger funds count more than smaller ones) was .69 percent last year. However, this average is heavily influenced by the rock-bottom expenses charged by Vanguard, the second-largest provider of target date funds. It charged an average expense ratio of .19 percent on its target date funds.

This means if you are offered target date funds from anyone other than Vanguard, you could be paying significantly more than the .69 percent average. More than half of the target date funds available charge 1.0 percent or more, according to Morningstar.

My advice is if the target date funds you are offered charged more than .75 percent, then I'd consider other investment options in your 401(k) plan if available. Check to see if the target date funds are more or less expensive or about the same as your other investment options.

One last issue to consider when reviewing target date funds is the fund makeup. Typically, target date funds are constructed using other mutual funds. In some cases the underlying funds might be stellar choices, but in many instances, they're plain dogs. Inclusion in a target date fund can be one way to boost the assets – and as a result the profits -- of an underperforming mutual fund.

If available, give serious consideration to a target date fund that is built with index funds like those offered by Vanguard. This approach should mean lower expenses and less chance of getting stuck with an actively managed fund that has underperformed.

Follow these steps and you're less likely to get caught off guard by your target date fund, no matter what government action results from the 2008 disaster.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

David McPherson is a Certified Financial Planner professional and founder of Four Ponds Financial Planning LLC (www.fourpondsfinancial.com) in Falmouth and Mansfield, Mass. Contact McPherson at david@fourpondsfinancial.com

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