Diversify our Target Fund?

[TeamSave]

I'm a newbie on this forum and have enjoyed what I've read so far. My question is that my wife and I both work for the same company. This company uses T Rowe directly for our 401K plan and we have to decide how to allocate the contribution. We have chosen the Target Fund 2040 because of its simplicity and diversification for both 401 plans. However, are we diversified enough if we both chose this plan even though the actual fund is fairly diversified? We are both around 30. Thanks in advance for any suggestions.

[sweeps]

The target funds themselves are designed to be fully diversified. You can actually become "un-diversified" by owning a target fund and another fund because you will likely become overweighted on some sector.

Having said that:
(1) You may want to become overweighted on a sector on purpose. Maybe you want 30% in international stocks instead of 20%, for example, so you would take some money from the target fund and put it in an international stock fund.
(2) Full diversification is just an opinion. Just look at the target 2040 fund between Fidelity, Vanguard, and T.Rowe Price -- they all have differences in their allocations. There is no perfect answer for what your allocation should be.

[jIM_Ohio]

You are fully diversified with a target fund.

Simple decision, works and you can leave this be until you need to retire.

If you have other T Rowe funds in your 401k, you could consider getting more aggressive and using an asset allocation which should beat the target fund's return.

Target 2040 holds 89% equity, 11% bonds:

The holdings:
Equity Index 500 Fund
Growth Stock Fund
High Yield Fund
International Growth & Income Fund
International Stock Fund
Mid-Cap Growth Fund
Mid-Cap Value Fund
New Income Fund
Overseas Stock Fund
Value Fund

If you overweighted the bold funds and removed the red ones you would probably beat the returns of the target funds. Add a small cap fund to the mix and you would probably do even better- I'm actually surprised there is not a small cap fund in the target fund.

[Broken Arrow]

However, are we diversified enough if we both chose this plan even though the actual fund is fairly diversified?

Yes. If all of your accounts are of the same target fund, from the same mutual fund company, then regardless of how many people are involved (single or couple) and regardless of how many accounts are involved (401k, IRA, or both), the effect will still be about the same....

Even if they're slightly different funds, and... perhaps even with different brokerages... it may still be diversified enough for all practical purposes. But I would X-Ray it to be sure.

Target funds are great. I heartily recommend them. However, target funds are not the divine last word on what diversification should look like. So, not every security in every fund needs to align perfectly.

In fact, I believe there is no such thing as perfect diversification. But again, for all practical purposes, so long as you have something that's diversified enough, you'll be in good shape. And I think you're in good shape.

[Scanner]

As Bill Clinton would say, "Define is"

Depends on what you mean by diversification.

There are basically 5 types of investments you can make:

1. Stocks
2. Bonds
3. Real Estate
4. Commodities
5. Cash

You only own 2 sectors with Target Fund.

I would look to own at least some of 3 and 4 for the beginning part of your portfolio. As you age, you can reduce your positions in commodities and stocks.

[jIM_Ohio]

As Bill Clinton would say, "Define is"

Depends on what you mean by diversification.

There are basically 5 types of investments you can make:

1. Stocks
2. Bonds
3. Real Estate
4. Commodities
5. Cash

You only own 2 sectors with Target Fund.

I would look to own at least some of 3 and 4 for the beginning part of your portfolio. As you age, you can reduce your positions in commodities and stocks.

The opposite point of view (and the one I follow) is that growth needs fewer asset classes and stability needs more asset classes. Meaning when you accumulate money, stocks have tended to give 8-12% returns over time, and none of the other 4 listed even come close. Maybe 6% for bonds, 5% for real estate, 5-6% for commodities and 2-3% for cash. Measured over 10 year periods or more.

As you need the portfolio to stablize in value, add the other asset classes. There are 7 asset classes in the stable portfolio model I have read about:

1) Large cap domestic stocks
2) mid and small cap domestic stocks
3) international large cap stocks
4) bonds-global
5) cash
6) real estate (REITs)
7) commodities

The purpose of the stable value portfolio is to reduce risk when drawing down (reduce the risk of drawing down a portfolio with a negative return that year in particular).

If you are still saving, that portfolio of 7 asset classes means little to you. IMO.

[Broken Arrow]

Good point, Jim! Agreed.

[LuxLiving]

I might suggest that one of you go w/either a 2035 or a 2045 fund just for kicks and giggles. Heck I'd go with the earlier one in case you want to retire a bit early. Either one of these is likely to be very similar to what you have in the 2040 Target fund.