How I Slash Retirement Account Fees: A D-I-Y Target Date Fund

I watched the disturbing Frontline documentary on PBS, The Retirement Gamble, and not surprisingly, I got to thinking about the fees I pay for investing in my retirement accounts.

On average, 401(k) fees reduce investment returns by 1 to 2 percent a year. As I read in this Next Avenue post, the Demos think tank published a report last year estimating that a median-income, two-earner household will pay nearly $155,000 in 401(k) fees over the course of the two workers’ lifetimes.

Like many of you, I’m on my second act and run my own solo business. I don’t have to sweat 401 (k) fees per se. But I do need to keep a sharp eye on the fees I pay for the investments in my IRA accounts.

Fighting Fees With Index Funds

One way I trim the fees charged by fund companies on my retirement accounts is to invest in a handful of stock and bond index funds, which carry expense ratios ranging from .05 percent to .16 percent.

Equity fund investors in 2012 paid an average expense ratio of .77 percent for equity funds that are actively managed by professionals, according to the Investment Company Institute.

Index mutual funds, on the other hand, cost on average, 0.14 percent for equity funds and 0.13 percent for bond funds, according to Bloomberg’s An Investor’s Guide to Fees and Expenses.

Since I don’t have the desire to research and pick and choose specific investments and tweak a lot, I tend to favor low-cost index funds.

But I also fancy the simplicity of target-date retirement funds which increasingly 401 (k) plans are offering, too.

With a target-date retirement fund, you select the year you’d like to retire and buy a mutual fund with that year in its name (like Target 2025, for me). The fund manager then splits up your investment between stocks and bonds, changing that division to a more conservative blend as the target date looms, or soon after.

There are drawbacks to these funds as Roger Wohlner, a savvy financial planner whose advice I respect, writes in his post on what to consider before investing in one. Fact is, they aren’t necessarily cheap.

“In some cases, the overall expense ratio may be a weighted average of the underlying funds. Others may also tack on a management fee to cover the costs of managing the fund,” he writes.

Last year, actively-managed target-date funds had an expense ratio— on average, of .58 percent, according to the Investment Company Institute.

But I merely use these funds as a blueprint model, then add my own with a twist–I build my own target-date retirement fund.

Setting Up a DIY Target-Date Fund

I set up my own DIY target-date retirement fund in a self-directed IRA at a no-load mutual fund company. Right now, it consists of four stock and bond mutual funds that work like one target-date fund. As I make my regular annual contribution to my retirement savings, I pick which of these funds to add to.

I explained this strategy in a post for Next Avenue, but feel compelled to reveal my approach here for my Second Verse readers who may have been flummoxed about where to invest IRA contributions for 2012 a few weeks back and casting around for 2013 choices.

If this appeals to you, you might research target-date fund families to find a fund with the date that suits your retirement horizon. The major target-date fund families are Fidelity, T. Rowe Price, and Vanguard, though many financial institutions offer them, too.

Locate the target fund on its company’s website and find what percentage of the fund is in stocks, bonds and cash, and which mutual funds the target-date fund invests in.

I chose Vanguard because my husband and I already invest in no-load index funds with the company and the firm focuses on index funds for its target-date funds.

I discovered that Vanguard’s Target Retirement 2025 Fund, for example, invests in three Vanguard index funds, now holding approximately 70 percent of assets in equities through a Total Stock Market Index Fund and a Total International Stock Index. The remaining 30 percent of the Vanguard 2025 fund is invested in bonds.

Within seven years after 2025, the Vanguard fund’s asset allocation gets more conservative. At that point, the fund is expected to hold around 70 percent of assets in bonds and cash, and about 30 percent in U.S. and international stocks. By the way, The Vanguard Target-Date Index Fund 2025 has an expense ratio of .17 percent.

Make it Your Own

In general, I stick to Vanguard’s strategy, but truthfully, I’m game for a little more risk and potential upside growth, given that I actually don’t think I will tap these funds for two decades. So I have added a dollop to Vanguard’s emerging markets index fund as well. As a result, my 2025 target fund is a little heavier in equities than Vanguard’s, but not terribly.

That’s the beauty of my approach. I can tweak the weighting of stocks and bonds in my individual DIY target-date fund to suit my personal risk tolerance level.

I like that feeling of having a little more control of my retirement fund.

Importantly, though, I’m shaving the fees I pay. And that may make all the difference.

Follow me on Twitter, @KerryHannon I’m the author of Great Jobs for Everyone 50+: Finding Work That Keeps You Happy and Healthy … And Pays the Bills (John Wiley & Sons), available here www.kerryhannon.com. Check out my column at AARP. My weekly column at PBS’s NextAvenue.org is here.