Saving in a dedicated retirement plan is a great way to help ensure that you have enough money to cover your expenses once you stop working. And if your employer offers a 401(k), it pays to sign up for it. Not only are contributions seamless -- they're deducted from your paychecks so you don't have to make any effort to get that money into your account -- but many companies offer matching programs that help you score free retirement cash.
But if you want to put your 401(k) to good use, you'll need to invest it. And here are three options to look at in that regard.
1. Target date funds
Target date funds are mutual funds that adjust your investments over time to meet a specific objective or milestone. With a retirement target date fund, you'll generally see more aggressive investments when that stage of life is years away, but over time, that fund will shift toward safer investments as retirement nears.
Target date funds are a good bet if you're clueless about investing and really don't want to learn. But they also have their drawbacks. For one thing, some target date funds are too conservative, and keeping your retirement cash in one could mean stunting your 401(k)'s growth. Furthermore, the fees you'll pay for a target date fund can be high, thereby eating away at your returns. You'll need to weigh the convenience of target date funds against their drawbacks to see if they're right for you.
2. Index funds
Index funds are passively managed mutual funds that aim to match the performance of the market indexes they're tied to. An S&P 500 index fund, for example, will aim to mimic the performance of the S&P 500 itself.
Like target date funds, index funds don't require a lot of legwork on your part, and their fees are very low. The only downside with index funds is that they won't help you outperform the broad market, since that's not their objective.
3. Actively managed mutual funds
Actively managed funds hire analysts to hand-pick investments in the hopes of beating the market. The upside? You could see some seriously solid returns in your 401(k). The downside? The fees can get expensive. In fact, it's not uncommon for actively managed mutual funds to charge fees that are 10 times as high as what you might pay for an index fund, since you're paying the salary of professionals who are selecting investments from a very large pool.
What's the right call for you?
If you open a 401(k) through your employer and don't make an election with regard to your investments, you'll generally wind up in a target date fund until you say otherwise. And that may not be a terrible choice for you. But rather than settle on it, consider the other options that are available in your plan. Some 401(k)s offer several dozen investment choices, while others offer fewer. But either way, plan to spend some time reviewing your options to decide what's best for you.