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Friday, May 27, 2011

Go the LifeCycle or Target Fund Route?

Don't know how to invest? You or your progeny got better things to do than worry about retirement and building a nest egg? The mere mention of asset allocation give you a headache?

No problem - choose a lifecycle or target date fund and leave the driving to someone else. At least that's a bit of advice widely proffered by both financial planners as well as fund providers. The lifecycle/target date funds do the asset allocation and rebalance over time. What's not to like? Well, the fee for one thing. So let's get out some Excedrin and take another look

Consider the Fidelity Freedom 2050 Fund (FFFHX), a typical recommendation for, say, a 25-year-old who doesn't want to make fund choices. The 2050 fund charges .84%. Put monies into the fund out of every paycheck for the next 39 years, and it will take care of the whole kit-n-kaboodle - at an expense of .84% of the market value of assets each year.

What's the alternative? One possibility is to mimic the basic asset allocation of the 2050 fund. By going to the summary sheet, you can easily find the fund's composition. For example, the fund holds 55% domestic equity. This can be mimicked with the Spartan Total Market index fund (FSTMX) - expense ratio .10%. The 2050 Fund holds 24% in the international equity sector - mimic with FSIIX - expense ratio of 20 basis points. Similarly with bonds.

This portfolio so constructed will have an expense ratio of between .10% and .20%, which, over a long period of time, makes a difference compared to the .84% expense ratio of the 2050 fund. The alternative portfolio will be a bit different from the 2050 Fund because it won't contain some parts of the 2050 fund - like the commodity, the emerging countries, or the high yield bonds sectors. These can be picked up at a later point with monies invested outside the 401k - in a Roth, for example.



Finally, the fund composition should be checked yearly to examine changes in composition. Over time, the portfolio will get more conservative by shifting from equities to fixed income.

This approach produces a slightly different portfolio as mentioned above. The bet is that the differences won't produce materially different performance. In fact, the wailing and gnashing of teeth by the investment community recently over the correlation among asset class returns suggests this could be the case. In any event, the cost is materially reduced with a portfolio costing approximately 15 basis points/year versus 84 basis points/year.

It may  pay to sit down with a professional, pay them an hourly fee, and get set up. I would even start with your 401k rep if interested in going this route - either way it should minimize any resulting headaches.

Disclosure:  This information is for educational purposes only. Investors should consult with professionals and do their own research before investing.

3 comments:

  1. It's a good option though the ER is slightly on the higher side.

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  2. How about the Vanguard Target Retirement funds?

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  3. re: MoneyCone The higher fees add up over time.
    re: Andrew Vanguard is a good way to go (fees under .20%) if available in your 401k. Do check account fees though.

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