Why Your 401(k) Default Investment Is Probably Terrible (And What to Do About It)
Most Americans have $87,000 sitting in a Vanguard Target Retirement 2050 fund right now and don't even know it. When you signed up for your company's 401(k), HR probably auto-enrolled you into whatever target-date fund matched your expected retirement year. Easy, right?
Wrong. These "set it and forget it" funds are costing you serious money.
The Target-Date Fund Problem
Target-date funds sound brilliant in theory. Pick 2050 if you plan to retire around then, and the fund automatically shifts from aggressive stocks when you're young to conservative bonds as you age. Vanguard's Target Retirement 2050 fund starts with 90% stocks and 10% bonds, then gradually becomes more conservative.
But here's what they don't tell you: these funds are designed for the most risk-averse investor possible. The person who panics and sells everything during market crashes.
The Math Behind the Mediocrity
Let's run some real numbers. Vanguard's Target Retirement 2050 fund (VFIFX) has returned about 8.2% annually since inception. Sounds decent until you compare it to a simple three-fund portfolio:
- 70% Total Stock Market Index (VTSAX): ~10% annual return
- 20% International Stock Index (VTIAX): ~7% annual return
- 10% Bond Index (VBTLX): ~4% annual return
This basic portfolio has historically returned around 9.1% annually - nearly a full percentage point higher than the target-date fund.
On a $500 monthly contribution over 30 years, that difference equals $180,000 less in your retirement account. That's not a rounding error - that's a whole extra decade of financial freedom.
The Surprising Truth About Risk
Here's where conventional wisdom gets it backwards: target-date funds actually make investing riskier for most people, not safer.
They shift you into bonds way too early. The Target 2050 fund will be 50% bonds by the time you're 50 years old. But if you're planning to live until 85 (and you probably will), you still have 35 years of investing ahead of you. Why are you investing like a retiree?
Inflation is the real enemy, especially for younger investors. Bonds might feel "safe," but they've barely kept pace with inflation historically. From 1926 to 2020, stocks averaged 10.2% returns while bonds managed just 5.3%.
Building Your Own Portfolio
The Simple Three-Fund Approach
Skip the target-date fund entirely. Most 401(k) plans offer these basic building blocks:
- Total Stock Market Index (or S&P 500): 70-80% of your portfolio
- International Stock Index: 10-20% of your portfolio
- Bond Index: 10-20% of your portfolio (and only if you're over 40)
Fidelity's equivalents are FXAIX for stocks, FTIHX for international, and FXNAX for bonds. The expense ratios are nearly identical to Vanguard - around 0.02% to 0.05%.
Age-Based Allocation Rules
Forget the "100 minus your age in stocks" rule. That's from when people died at 65, not 85.
Here's a better framework:
- Ages 22-35: 90% stocks (70% US, 20% international), 10% bonds
- Ages 35-50: 80% stocks (60% US, 20% international), 20% bonds
- Ages 50-65: 70% stocks (50% US, 20% international), 30% bonds
Yes, this keeps you more aggressive longer. That's the point.
When Target-Date Funds Actually Make Sense
I'm not completely against target-date funds. They work for exactly one type of person: someone who will never, ever look at their account balance during market crashes.
If you're the type who checked your 401(k) daily during March 2020 and felt sick watching it drop 35%, stick with target-date funds. The conservative allocation will save you from yourself.
But if you can handle volatility - and you should learn to, because that's how wealth gets built - you can do much better on your own.
The Rebalancing Reality Check
The biggest argument for target-date funds is automatic rebalancing. "I'll forget to rebalance my portfolio," people say.
Honestly? You only need to rebalance once per year, maybe twice. Set a calendar reminder for January 1st. Takes 10 minutes. If that's too much work for an extra $180,000, investing might not be for you.
Making the Switch
Most 401(k) plans let you change your allocation online. Log into your account, find the "change investments" section, and redirect future contributions to your chosen funds.
For money already invested in target-date funds, you can usually do an "exchange" or "transfer" to move existing balances. Some plans limit how often you can make changes (typically once per quarter), so plan accordingly.
Your Next Move
Log into your 401(k) account right now. Check what funds you're invested in and their expense ratios. If you're in a target-date fund charging more than 0.20%, you're overpaying for mediocre returns.
Pick a simple three-fund portfolio based on your age, make the switch, and set a yearly reminder to rebalance. Your future self will thank you - to the tune of six figures.