Workplace retirement savings plans, such as the 401(k), have made a number of improvements over the years to get workers to a better financial position. Things like automatic enrollment and the option for automatic periodic contribution increases have been immensely helpful in getting people to save more money and accumulate wealth for longer than they would have in the past.
The use of target-date funds, which put people in an age-appropriate asset allocation that automatically adjusts over time to be more conservative as the person gets older, has been another improvement. This one, however, has its problems. Putting some workers in an investment based only on their age ignores personal risk tolerances, preferences, or objectives.
The funds are a good thing, but not a great thing. And they are something that can cost you thousands of dollars or more if the ones you get put in are not the right fit for you.
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Default investing options in 401(k) plans might be too conservative
Let’s create a hypothetical example of a worker just starting a new job at a new company. She’s 30 years old and is enrolling in the company’s 401(k) plan. She doesn’t know a lot about investing or what she should put her money in, so she accepts the plan’s default option based on her age. For her, that default option might be something like the Vanguard Target Retirement 2060 Fund, given that she’s got about 35 years until she turns 65.
Real-time asset allocations will vary over time with market movements, but the fund’s prospectus states that a recent target allocation was set at:
- 36% FTSE Global All Cap ex US Index
- 7% Bloomberg U.S. Aggregate Float Adjusted Index
- 3% Bloomberg Global Aggregate ex-USD Float Adjusted RIC Capped Index (USD Hedged)
- 54% CRSP US Total Market Index
In other words, 90% stocks and 10% bonds.
There’s nothing inherently wrong with that asset allocation choice. But it’s worth noting that a 10% allocation to fixed income over the course of more than three decades can create a real performance drag. Here’s an example to consider. It’s a breakdown of how a 100% U.S. stock portfolio would have fared against one with 90% U.S. stocks and 10% U.S. bonds going back to 1987.
| Metric | 90% U.S. Stock Market / 10% U.S. Bond Market | 100% U.S. Stock Market |
|---|---|---|
| Start balance | $10,000 | $10,000 |
| End balance | $513,014 | $605,802 |
| Annualized return (compound annual growth rate) | 10.53% | 11% |
| Standard deviation | 13.95% | 15.44% |
| Best year | 34.03% | 35.79% |
| Worst year | (32.83%) | (37.04%) |
| Maximum drawdown | (46.16%) | (50.89%) |
Data tool: Portfolio Visualizer. Date range: January 1987 to April 2026.
The difference over this nearly 40-year period is almost $100,000. An all-stock portfolio comes with deeper drawdowns and higher overall volatility levels, and there’s no guarantee stocks will always go up. But in this example, the all-stock portfolio would have come with better performance of roughly 0.5% annually. And that would include the Black Monday crash of 1987, the tech bubble, the global financial crisis of 2007-2009, and the start of the COVID-19 pandemic.
The benefit of choosing your own investments
With decades to invest, opting out of a default investment option, which could be too conservative for your situation, might be the best choice. Even investing in an S&P 500 (^GSPC +0.22%) fund or a total stock market fund, which would give you 100% equity exposure, has a better chance of producing superior returns over that long of a time frame. Yes, it’ll probably be a modestly more volatile ride, and you’ll need to buy and hold throughout bear markets, recessions, and market events in order to achieve those returns. But if you can do it, you might find yourself adding tens of thousands of dollars to your retirement plan balance.
The most important thing, however, is starting and continuing to invest. If a target-date fund makes it easier to do that, by all means, choose that. But choosing the more equity-heavy option could prove to be more lucrative.
