Dear Liz: I have 100% of my 401(k) in a fund called “Target Retirement 2030.” This fund is made of several other funds, so does that qualify as “diversified”?
Answer: It does. Target date funds have become increasingly popular in 401(k) plans because they do the heavy lifting for investors. The funds select asset allocations and grow more conservative in their mix as the retirement date approaches.
Target date funds aren’t perfect, of course. Some are too expensive. The typical target date fund charges about 1%, but Vanguard and Fidelity charge as little as 0.15%.
Another issue is the “glide path” — how quickly the funds get more conservative. There’s no consensus about what the right glide path should be, and investment companies offer a lot of different mixes. Any given glide path may be too steep for some people and too shallow for others, depending on their circumstances. As an investor, you can compensate for that by choosing funds dated later or earlier than your targeted retirement date. If the 2030 fund gets too conservative too fast for your taste, for example, you could choose the 2040 fund instead.
Despite the downsides, you’re likely to be much better off in a target date fund than you are in some of the other options. Too often novice investors take too much or too little risk without realizing it. They may have all of their money in “safe” low-return options, which means they’re losing ground to inflation. Or they may have all their money in stocks, including their own company’s stock, and would be unprepared for a downturn wiping out a good chunk of their portfolio’s value.
Even those who know they should diversify often do it wrong by randomly distributing their contributions across their investment options. If you don’t know what you’re doing, or you simply prefer investing professionals to take charge, target date funds are a good way to go.