The Target-Date Fund Mistake That Could Cost You

The Target-Date Fund Mistake That Could Cost You

When it comes to your diet or your investment portfolio, diversity is generally a good thing.

But sometimes, variety can hurt you.

According to a new study from Financial Engines and Aon Hewitt, only about one-third of people investing in target-date funds use them as “one-stop” 401(k) investments.

The problem? Target-date funds are a mix of stocks, bonds and cash tailored to the risk level appropriate for your expected retirement date—and the allocation shifts (to a more conservative ratio) as you get older. Placing money elsewhere—in addition to a target-date fund—may actually result in a portfolio that's mismatched with the risk level associated with an investor's age.

In other words, underutilizing target-date investments can hurt users in the long run.

Between 2006 and 2012, researchers surveyed 723,000 employees at 14 U.S. companies about their 401(k) investing styles. Among those who used target-date funds, most also held money in other investments. On average, people placed 35% of their investments in target-date funds.

And, unfortunately, as a result, partial target-date fund users raked in about 2.1% less each year than their peers who invested at least 95% of their portfolio in a target-date fund between 2010 and 2012.

"Putting all your eggs in one basket is usually a bad idea," Wei-Yin Hu, vice president of financial research at Financial Engines, told CNN Money. "But these funds are designed to allow you to do that."

As CNN Money reports, target-date funds can be especially useful for amateur investors, since you don’t have to discern your own combination of stocks and bonds. But if you feel uncomfortable putting all your retirement savings into a single fund, that's O.K.—many 401(k) providers can help you design a portfolio that’s suitable for your age.

But if you are interested in investing in a target-date fund, don't forget to check out the expense ratio, or the amount it costs to manage the fund.

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