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How to gum up your 401(k) without even knowing it

Half of target-date fund investors have their dollars in other funds

If you've invested only some of your 401(k) savings in a target-date fund, you may be doing it wrong.

A recent analysis of about 100 large retirement plans by Aon Hewitt, a human resources consultancy, showed that about half of the 1.5 million participants surveyed who use target-date funds spread their dollars across other investments available to them in their plans.

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That's a problem because target-date funds tend to move toward more conservative investment allocations as investors age, so savers who spread their money out across target-date funds and other options are messing up their exposure to fixed income and equities. As a result, they be taking on more or less risk than they anticipated.

The remaining half of the investors in the analysis used target-date funds exclusively.

"People don't realize that these funds are designed to be 'all-in,'" said Rob Austin, director of retirement research for Aon Hewitt. "We know behind the scenes that target-date funds are a basket of different funds, but it doesn't always appear that way to certain individuals."

Target-date funds, which are a mix of equity and bond funds, have become a staple of 401(k)s. About nine out of 10 plans offered them in 2015, compared to a third of plans in 2005, according to Aon.

Here are a few reasons why you should rethink your asset allocation — even if you're in a target-date fund.

Performance will vary

Looking at only 2015, individuals who weren't invested in target-date funds beat those who were fully invested in them, according to Aon's research. While the S&P 500 index had a return of 1.4 percent that year, low returns in other market sectors dragged the funds' performance into negative territory.

Yet over time, participants who allocated all of their 401(k) savings toward target-date funds generally beat those who didn't use them.

This effect is more pronounced among younger participants in their 20s and 30s, who are most likely auto-enrolled into these funds. These investors also outperformed those who are only partially invested in target dates, according to Aon's findings, outlined in the chart below.

Target-date funds have their shortcomings; many of them were clobbered in 2008 when the stock market tumbled.

The benefit, however, is that they offer some hope of diversification, and it's done by a professional.

"The Pension Protection Act of 2006 made target-date funds very popular, and they became the default option in plans," said Katie Taylor, a director of thought leadership at Fidelity. "Prior to that, almost 35 percent of participants had extreme portfolios: zero in equities or 100 percent in equities."

Today, 12 percent of savers have these extreme allocations.

Everyone's different

The target-date fund available at your workplace assumes that employees who are at or about the same age will invest in the same way. Your concentrations toward stocks and bonds are adjusted for your estimated retirement time horizon.

Keep in mind, however, that your 401(k) allocation doesn't necessarily reflect the bigger picture of your personal finances.

"You can have two people who are 45: One is putting a kid through college, but the other might have a pension plan," Austin explained. "One might have a house that's paid for, and the other might not."

"They should be invested differently for retirement, and a target-date fund won't reflect that," he said.

At Fidelity, 36 percent of 401(k) plan participants have money in target-date funds and in other investments.

"It doesn't necessarily mean that they're doing something wrong," said Taylor of Fidelity. "What if they had their employer's money going in and it had to be invested in a particular account, like a stock fund?"

Make a decision

Instead of splitting your deferrals across all of the available funds in your plan, think about your approach toward investing: Are you a do-it-yourselfer who will research and monitor your chosen funds? Or do you prefer to be hands off?

"If you don't know what you want to do, then go with the target-date fund," said Aaron Pottichen, president of retirement services at CLS Partners in Austin. "If you do know how you want to invest, then don't go into the target-date fund."

Fees also matter. They average target-date fund had an expense ratio of 73 basis points in 2015, according to Morningstar.

Costs are even lower if you look at target-date funds that are comprised of index funds. Vanguard's lineup, for instance, has an average expense ratio of 13 basis points. A basis point is one-hundredth of 1 percent.

Regardless of how you invest, be sure to check your account at least annually. Make sure that your strategy still works for you and that you're deferring as much as you can, Taylor said.

If you want your 401(k) to reflect your overall financial picture, including assets you hold outside of your plan, you may want to consult with a financial planner. "Everyone needs a plan in place to know how they should be invested for that time in their life," Pottichen said. "As they get older, how does that change?"