A 401(k) can be a great place to stash your retirement savings, but how well it works for you depends in part on what you invest in. Choosing investments can be intimidating, especially for those who have never done it before. But you don't need to be an expert to do a great job. Here's one strategy that can make managing your investments effortless.
This could be the only investment you need
Part of what makes investing so complex is that people's needs change over time. When they're younger, most people invest more in stocks, which have higher earning potential but also carry greater risk. As people age, they begin moving more of their savings into safer investments like bonds. These don't grow as quickly, but the risk of loss is smaller, which is important when retirement is near.
These changes mean you have to regularly adjust your holdings to accommodate your changing risk tolerance. It's not something everyone feels comfortable doing, but fortunately, with a target-date fund, you don't have to.
Target-date funds are bundles of investments you purchase together, and their composition is designed to change over time to reflect your declining risk tolerance. These funds usually have some sort of a date in their title, and this represents the year in which you plan to retire. The fund managers use this timeline as their guide when choosing investments, and they take charge of adjusting the assets in the fund as needed.
It's a really simple way to invest, and many companies that automatically enroll workers in their 401(k)s use some sort of target-date fund. The only thing you really have to know to use one of these is the approximate year you plan to retire. You should also investigate the fees associated with your fund. Then, you just start depositing money and check in periodically to see how you're doing.
Is investing this way a good idea?
A target-date fund can be a good fit for those who don't feel comfortable choosing the stocks and bonds that make up their retirement savings. It's also a smart choice for those who lack the time to pay close attention to how their investments are performing. However, there are a few downsides to this approach as well.
Target-date funds can carry higher fees than other types of investments, and these fees eat into the growth of your savings compared to low-cost investments like index funds.
How much you'll pay for a target-date fund depends on how much you have invested in it. Most funds report an expense ratio, which is a percentage of your assets. If the target-date fund has a 1% expense ratio, that means you're paying 1% of all the money you have in the fund to the fund manager each year. Try to avoid paying any more than 1%, so you can hold on to more of your earnings.
Target-date funds are also designed for a "typical" person retiring in the chosen year, but they aren't tailored to your specific circumstances. And they rely upon you to choose the correct year. If you don't end up retiring in the target year, you might find your asset allocation is either too conservative or too risky for your actual retirement timeline.
But for most people, the pros of target-date funds still outweigh the cons. If you like this hands-off approach to retirement saving, a target-date fund could be a great fit for you. You can always change your mind down the road if you decide you'd like to take a more active role in choosing your investments.