Chances are, you have most of your retirement savings sitting in your 401(k). That's a smart move -- 401k investing is convenient, tax-advantaged, and effective over the long term, particularly when you have access to employer-matching contributions and good mutual funds.
The availability of solid mutual funds, unfortunately, varies widely across the 401(k) universe. The smallest plans may only offer a handful of pricey funds, while larger plans may provide 20 or more fund options from a big-name fund family like Vanguard or Fidelity. Hopefully, your plan leans toward the latter with a mix of target-date funds, balanced funds, and low-cost, broad market funds.
Here's a look at those three mutual fund categories, plus nine top-rated mutual funds that fall within them. If your 401(k) plan doesn't offer these exact funds, use them as benchmarks to evaluate the options you do have.
Target-date funds for low maintenance
Target-date funds are arguably the lowest-maintenance asset you can buy in your 401(k). These funds gradually become more conservative over time as your retirement date approaches. The idea is to pursue growth when retirement is decades away, and then shift to a defensive stance focused on capital preservation once you retire.
The advantage of target-date investing is that you don't have to do much once you select a fund that's aligned with the year you intend to retire. If the target-date fund is your only position, you won't need to rebalance every year -- though you should keep tabs on the fund's performance and its changing asset allocation.
The table below compares 2045 target-date funds from Fidelity Freedom, American Funds, and T. Rowe Price. You can see the American Funds 2045 fund has the highest expense ratio of the three, but it's also the largest and has the strongest 10-year return. Note that if your plan offers one of these fund series, you'll be able to choose a year that's near your targeted retirement date.
Fidelity Freedom Index 2045 (NASDAQMUTFUND: FIOFX)
American Funds 2045 Target Date (NASDAQMUTFUND: AAHTX)
T. Rowe Price Retirement 2045
Balanced funds for diversification across asset classes
Balanced funds offer another low-maintenance approach for retirement savings. A balanced fund invests across asset classes, usually in a stated asset allocation such as 60% stocks and 40% bonds.
As with a target-date fund, a balanced fund could be the only investment in your account. As long as you're comfortable with the fund's approach to asset allocation, you don't need to make any changes from year to year. Your asset allocation will remain constant, even as you start taking your retirement distributions.
The table below shows three five-star balanced funds as rated by Morningstar. Each targets 60% to 65% stocks, with the remainder in bonds and cash.
American Funds American Balanced (NASDAQMUTFUND: ABALX)
Fidelity Balanced (NASDAQMUTFUND: FBALX)
T. Rowe Price Capital Appreciation
Before settling on a balanced fund, review the prospectus and get comfortable with the fund's approach. These three funds may have similar equity allocations, but the allocations within equities differ. Of the three, American Funds Balanced (NASDAQMUTFUND: ABALX) has the lowest exposure to small caps and mid caps. That contributes to slower growth and lesser volatility.
Broad market funds
You can also build your 401(k) portfolio with three to five broad market funds. The advantage here is that these funds tend to have lower expense ratios than target-date or balanced funds. If you're willing to manage multiple funds over time, combining broad market mutual funds is a cost-effective approach that still provides diversification across asset classes.
You don't need more than one fund family to make this happen, either. If you have access to Vanguard funds in your 401(k), for example, you could invest in Vanguard Total Stock Market Index (NASDAQMUTFUND: VTSAX), Vanguard Total International Stock Index (NASDAQMUTFUND: VGTSX), and Vanguard Total Bond Market for a complete portfolio. As you can see in the table below, all three Vanguard funds have expense ratios below .20%.
Vanguard Total Stock Market Index (NASDAQMUTFUND: VTSAX)
Total U.S. Stock Market Index Fund
Vanguard Total International Stock Index (NASDAQMUTFUND: VGTSX)
Total International Stock Index Fund
Vanguard Total Bond Market Index (NASDAQMUTFUND: VBMFX)
Total Bond Market Index Fund
If you prefer to keep your 401(k) low-maintenance, a target-date fund or balanced fund will be a good fit. If you'd rather have a few funds to manage and rebalance periodically, build your portfolio from broad market index funds, instead. Either approach gives you exposure to both stocks and bonds, which makes for lower volatility over time.
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