Like baking a cake, if you don’t get the mix right in your retirement portfolio, the final product won’t come out right. The ingredients have to be in the right proportions.
In the investing world, getting the mix right is called “asset allocation.” It’s a dry way of saying how you combine stocks, bonds, real estate and cash.
If you get the mix right — combined with sufficient saving — you’ll get enough of a retirement kitty to retire with dignity. Most employers, however, don’t give you much education on the best strategy.
Here’s what millions of recently-hired investors are doing in their retirement portfolios, according to EBRI:
– Balanced Funds. “The EBRI/ICI 401(k) database shows that participants tended to be more likely to hold balanced funds compared with recent hires in the past. About two-thirds of recently hired 401(k) plan participants from 2011 through 2014 held balanced funds, compared with less than half in 2006, and one-third in 2002.”
A balanced fund is one of the easiest vehicles to hold. It’s a mix of stocks and bonds, usually 60% stocks and 40% bonds.
While it’s not a perfect combination, it blunts risk in both markets. It’s a good core holding if you don’t want to pick individual funds.
“Among those who held balanced funds, recently hired participants in 2014 were more likely to hold a high concentration of their accounts in balanced funds compared with past years. At year-end 2014, 79 percent of recently hired participants holding balanced funds had more than 90 percent of their account balance invested in balanced funds, compared with 77 percent in 2013.”
– Target-Date Funds are becoming more popular. These pre-made portfolios hold individual stock, bond, cash and real estate funds. They ratchet down stock market risk the closer you get to retirement age.
“At year-end 2014, 59 percent of recently hired 401(k) participants held target-date funds, while 12 percent held non–target-date balanced funds, and 4 percent held both target-date and non–target-date balanced funds.”
If you’re not interested in picking from an array of individual funds, which vehicle — balanced or target-date funds — is the best long-term choice?
For the moment, I’m going to say target-date funds fit the bill with several caveats. They offer more diversification across several unrelated markets and make an attempt to mitigate risk. For most people, this auto-pilot approach should avoid trouble.
But here are my reservations about these funds: The portfolios can be pricey and may not make sense if you want a higher stock allocation as you get older.
Remember that you still need to beat inflation over time, particularly in retirement, so holding stocks is a better way to do that. Bonds are notoriously vulnerable when inflation rises — they can lose money.
On the expenses front, though, make sure that you’re not being charged more than 0.50% a year for annual expenses on your target-date portfolio. While the convenience is welcome, there’s no reason to be overcharged for it.
This article was written by John Wasik from Forbes and was legally licensed through the NewsCred publisher network.
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