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Fund on track if its risks are tolerable

Gail MarksJarvis
| Sunday, May 13, 2012, 1:08 p.m.

Q I work for a company with a 401(k). I'm 24 and investing in the T. Rowe 2055 investment fund. Am I investing the right amount and am I using the right year fund? I get a 2 percent match (of salary) from my company and I put in 3 percent of every paycheck.

-- D.G.

A The T. Rowe Price Retirement 2055 Fund, or any other so-called "target date fund" with 2055 in its name, is designed for someone your age. So theoretically your fund would be ideal for you. The number in the fund name is the year you will retire if you work to 67. Theoretically, when you look through a list of 401(k) mutual funds and find the one with the date you may retire, you have found all you need to know. But people need to understand a little more to know whether the fund is right for them.

First, if you continue to put money into this fund from every paycheck until you retire, you should never have to use any other mutual fund or pick any stock or bond. This is one-stop shopping.

But most important, you need to understand what the number in your fund tells your fund manager to do. By knowing your retirement date, the manager decides how much risk you should be taking in the stock market. So it's critical to understand his thinking so you can be sure you really want what the fund manager will give you.

When you are 24, the manager will put almost all your money into stocks. He knows that there will be times when you will lose a lot of money in the stock market, but he figures that over 43 years you will gain a lot more than you lose, and that will get you ready to retire. As you go through life, the manager will make changes in the quantity of stocks and bonds. So the closer you get to retirement, the less risk you will take in the stock market.

According to research by Morningstar, when you are in your 20s, the average manager will put about 90 percent of your money in stocks and about 10 percent in bonds. When you are in your 40s, the manager will put about 85 percent in stocks. In your 50s, it's 70 percent in stocks and 30 percent in bonds. And when you get close to retirement in your 60s, about 60 percent of your money will be invested in stocks, with 40 percent in bonds. When you get close to retirement, it's especially important to make sure you are at peace with the amount in stocks. T. Rowe Price, for example, has been keeping about 79 percent of a person's money in stocks at about age 55, so it's riskier than the average fund at only 70 percent in stocks.

While it might seem crazy at 24 to subject your money to this risk, you will be taking another risk if you don't. The risk with a safer choice such as a money market fund or a bond fund is that your money won't grow much. In the past 86 years, the stock market on average has made a person's money grow 9.8 percent a year. Long-term Treasury bonds have grown money about 5.7 percent. Over a lifetime, those gains make a huge difference.

Those gains, as averages, have resulted from many ups and downs in the stock market since before the Great Depression. Some years, the stock market crashes more than 30 percent. Other years, it can gain 30 percent or more.

That's why I said your fund was "theoretically" ideal for you. But if you will get nervous if your fund plunges in value, as it will on average every four years, then it's not right.

If you cut back on stocks, your losses won't be as great. And you can control that by buying a fund with a retirement date for someone older than you.

So to pick a target-date fund, you have to know your gut. If you are convinced you can endure the pain and hold on in the scariest moments, then you have the right fund.

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