One of the most intimidating parts about planning for retirement is deciding which investments you're going to place your precious dollars into. You want your money to grow quickly, but you also want to shield yourself from risk. If you're new to investing, you might not be able to tell the difference between one investment and the next.
Fortunately, there's a simple solution that can not only take the burden of deciding what to invest in off your shoulders but also remove any concerns about how to reallocate your funds as you age.
The problem with trying to craft a retirement plan on your own
Traditional retirement planning involves investing in a variety of stocks and bonds and then gradually shifting your money away from stocks and into bonds over time.
Investing heavily in stocks when you're younger enables you to capitalize on their higher earning potential, and if you lose money, you have plenty of time to make it back before you have to live off your savings. Shifting your money into lower-earning but less-volatile bonds as you age helps you protect what you have.
But a lot of people don't know how much to invest in each and how to reallocate their funds over time. Blind guessing could cause you to make mistakes that either put you at risk for huge losses or slow the growth of your savings.
You can hire someone to manage your money for you, but then you're paying them fees on top of the investment fees you already owe. If neither of those options appeal to you, a target date fund could be a smart choice.
This fund does all the hard work for you
Target date funds are collections of investments you purchase as a single package based on your chosen retirement year. You might see them listed as "2030 Fund" or something similar. The year listed in the name represents when you plan to retire.
When that date is a long way off, the investments in the fund will contain more stocks and other investments with greater earning potential. Then, over time, they'll shift more to bonds to protect what you have. Basically, it automates the asset reallocation process so you don't have to do it yourself. All you have to do is keep investing money in the target date fund that suits you.
For those who don't feel confident choosing their own investments, this simplicity is a huge plus. It enables you to manage your money on your own without worrying about whether you should sell some of your stocks or if a certain bond is a good investment for you.
Many employers offer target date funds to their employees through their 401(k)s, but you can invest in them through IRAs as well. Before you do, you should understand the trade-offs of this hands-off investing approach.
Things to know before investing in a target date fund
No two target date funds are exactly the same, even if they have the same target retirement year. In order to determine which one is the best fit for you, you have to evaluate their glide paths and fees.
The glide path is the rate at which the target date fund moves your money from stocks into safer investments, like bonds. One target date fund could have an asset allocation of 50% in stocks and 50% in bonds by the target retirement year, while another could have 60% in stocks and 40% in bonds.
It's up to you to determine which one you feel most comfortable with. It might seem safer to go with the one that shifts your money to bonds more quickly because you won't have to worry as much about losing your savings as you near retirement. But you could slow the growth of your nest egg considerably by doing so, forcing you to set aside more money of your own every month to reach your retirement goal.
Fees are also important to consider when selecting a target date fund, and unfortunately, many of them are high. Some charge shareholders over 1% of their assets per year. That means you're paying $1 or more for every $100 you have invested in the fund every year. But not all target date funds are this expensive. Some contain affordable exchange-traded funds (ETFs), and these can carry fees of less than 0.5% of your assets per year.
Target date funds aren't for everyone, but they're definitely worth considering if you're comfortable trading customization for automation. But if you feel confident choosing your own investments, you might be able to achieve your target goal more quickly and affordably by doing so. Think about your lifestyle and investing expertise to decide which is right for you.