For years, I ran my own business, and right around this time of year, I would get whipped up trying to pick mutual funds for my Individual Retirement Account (IRA).
As the April 15 tax filing deadline drew near, my accountant would shoot me the maximum amount I could contribute to my IRA based on my earnings, and then it was up to me to pick a winner, or a handful of them, to stash these retirement dollars.
As I was sweating this out one day in March, a buddy who is a sharp wealth adviser suggested I invest the lot of it in a target-date retirement fund — or take a crack at putting my own target-date fund together.
I’m not someone you would call a do-it-yourselfer. I don’t repaint bedrooms or refurnish antique tables I find at a flea market. But when it comes to my investments, I like feeling in control. Not to say that I’m a voracious self-manager who relishes researching stocks and timing buys and sells. I invest, for the most part, in market-tracking index mutual funds balanced across stocks, such as the S&P 500 index, and fixed-income bond funds.
That has worked for me. Index funds routinely clobber funds actively managed by professional stock pickers. And it’s why I set up my own custom target-date fund.
When 401(k) plan sponsors and state auto-IRA programs automatically enroll workers in a retirement plan, the majority use target-date funds. These funds are typically made up of a couple of index funds.
You select the year you’d like to retire and buy a mutual fund with that year in its name, like Target 2035. The fund manager then splits your investment between stocks and bonds, shifting to a more conservative mix as the target date nears.
It’s set-and-forget investing for what can stretch to decades and a boon for folks who want a hands-off approach.
And for anyone who wants to be slightly more hands-on, it’s replicable.
Step 1.Pick a date and research. I started by choosing my target date, in other words, the year I expected to retire. Then I researched target-date fund families to find a fund with the date I wanted.
Some of the biggest target-date fund families include Fidelity, T. Rowe Price, and Vanguard, though most financial institutions offer them.
Step 2.Check out the fund’s holdings. Find target-date funds from a few different firms that meet your year and see what percentage of the fund is in stocks, bonds, and cash, and which particular mutual funds the target-date fund invests in. These will be the guardrails for your selections.
I found the target-date fund that matched my criteria at Vanguard. Its portfolio managers invest in four index funds, holding approximately 70% of assets in equities through a total stock market index fund and a total international stock index fund. The remaining 30% is invested in a total bond fund and a total international bond fund.
The expense ratio: 0.08%. More on fees shortly.
Truthfully, that was a little tame for me. But I knew I could add a pinch more to my equity portion to align with my risk tolerance, or even add another equity index fund. Your allocations will depend on your target date, and the longer your time frame, the bigger the stock portion should be.
The comparable target-date fund at Fidelity was a tad more aggressive than Vanguard’s. Its equity portion is 74%. Expense ratio: 0.69%. At T. Rowe Price, its target-date fund managers were a notch more conservative, with around 64% invested in stocks. Expense ratio: 0.56%.
Fees may seem a pocket-sized price to pay, but they cut into the amount you have invested and that has a significant impact on your future nest egg. (Getty Creative) ·krisanapong detraphiphat via Getty Images
Step 3: Seek low expenses. You will discover that some target-date funds carry higher fees than the funds within them, and index target-date funds will be cheaper.
That was one incentive for me to build my own personal target-date fund.
It paid off: In total, my bespoke IRA account costs me 0.06% in fees, compared to 0.08% if I had invested via the actual target-date fund.
Fees may seem a pocket-sized price to pay, but they cut into the amount you have invested and that has a significant impact on your future nest egg.
Expense ratios typically vary by fund and reflect a variety of costs, including what a mutual fund or ETF pays for management advisory fees as well as the cost of marketing and selling the fund and other shareholder services, transfer-agent costs, and legal and accounting fees.
In 2023, index equity mutual funds had an asset-weighted average expense ratio of 0.05%, or just $5 for every $10,000 invested, according to research by the Investment Company Institute.
Compare that to 0.42%, or $42 for every $10,000, for actively managed equity mutual funds.
Target-date funds, however, are a tad pricer than a single equity index fund. Their fees reflect the asset-allocation monitoring by a fund manager on top of the fund expenses.
The average net expense ratio for target-date funds is 0.84%, per Morningstar Direct’s most recent research.
Vanguard currently has an average charge of 0.08% for its target-date funds. At Fidelity, the Fidelity Freedom target-date funds’ expense ratios run as high as 0.75%.
That is far above the Vanguard 500 Index Fund Admiral Shares expense ratio of 0.04%. Or Fidelity’s 500 Index Fund, which clocks in even lower at 0.015%.
Step 4: Add your funds. Once you open your IRA account, you simply echo your chosen target-date fund’s asset allocation model by dividing your investment dollars among the same funds the target fund holds, using its stock/bond/cash percentages to steer you.
You can then tweak the weighting of stock and bond funds to fit what feels comfortable to you.
As you contribute money throughout the year or in a lump sum, the key is to maintain those same ratios.
Step 5. Rebalance your holdings periodically. Once a year — say, at tax time — you’ll want to check in on the funds within the target date you’re imitating. Then, if your overall portfolio balance has changed because one of the funds has leapt up or fallen down, you can fine-tune your DIY holdings to get back to the level you want.
Financial advisers usually recommend rebalancing (adjusting your mix of stocks and bonds) whenever your portfolio gets more than 7% to 10% away from your original asset allocation, which was constructed to match your time horizon, risk tolerance, and financial goals.
Every time I log in to my account, I can see precisely where the asset allocation stands. I’ve made adjustments, but to be honest, even after a nerve-racking market slide. I typically sit on my hands. To me, this is bumper bowling.
With the mutual fund pros’ selections as my guide, I feel secure that I won’t dart into the gutter even when stocks slump.
