"Most fund companies don't have the skill set to outperform the market in every asset class -- large-cap, small-cap, non-U.S. equities and fixed income," O'Meara explains. "It's hard enough to outperform one market benchmark, but then when you start packaging 10 or 20 managers, most organizations are going to fail to outperform."
Fees. Most target funds are basically a fund of funds, so fees add up quickly. As always, index funds will be the least costly -- Vanguard's index target funds charge 18 basis points in expenses -- but some companies charge significantly more than 1% in expenses for actively managed target funds.
These fees take a big chunk out of your nest egg. According to a recent Towers Watson white paper, the average worker making $125,000 over the course of a career who pays $20 in fees for every $10,000 invested in target-date funds would lose three years worth of retirement income to fees. The same worker who paid $100 in fees for every $10,000 invested, would lose 15 years worth of retirement income. That's a lot of cruises and greens fees going to fund companies.
The Right Target. Making sure the target funds offering in your 401(k) are right for you takes a lot more work than simply picking the date closest to your retirement year.The way target funds are allocated among different asset classes up to and beyond your retirement varies widely. Some may keep a majority in stock, even past retirement date. Others may move to a majority in fixed income well before you retire. Still others may invest in REITs and commodities to further diversify the fund, which can be a good thing, especially if these sectors aren't represented elsewhere in your 401(k) investment menu. The point is investors still have to do plenty of homework to make sure their default option is invested the way they want it to be. There is no such thing as buy and forget. Because you have to manage target funds the same way you would any other investment, why not throw yourself in completely and come up with your own investment picks that offer diversification and -- one hopes -- much higher returns.
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