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3 Reasons to Load Up on Index Funds in Your Retirement Plan

By Maurie Backman - Apr 29, 2021 at 5:36AM

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Not sure how to invest your nest egg? Here's what makes index funds a good bet.

The money in your IRA or 401(k) plan shouldn't just sit there doing nothing. Rather, you need to invest that money so it grows into a larger sum in time for your senior years.

But investing your savings means having to make tough choices. Play it too safe, and you'll risk falling short by the time you retire. Get too aggressive, and you could lose money. If you're not sure how to invest your retirement savings, index funds are a good option to consider. Here's why.

Man looking at laptop screen

Image source: Getty Images.

1. There's less guesswork than picking individual stocks

Vetting stocks individually takes time. Plus, you need to know what you're looking for in terms of cash flow, debt management, and other financial metrics that may be over your head. The good thing about index funds is that you don't need to sink numerous hours into researching different options.

Index funds are designed to track different market indexes that already exist. An S&P 500 one, for example, will have the goal of matching the performance of the S&P index itself. If you choose to go this route, you can look at different funds' performances since inception to get a sense of how well they've fared throughout the years -- and then make your decision accordingly.

Another thing to keep in mind is that if you're saving for retirement in a 401(k), you generally won't even get the option to pick individual stocks. As such, index funds are an easy next-best choice.

2. You get immediate diversification

The money you sock away for your senior years is money you may need to get you through 20, 25, or 30 years of retirement -- if not more. As such, banking on a handful of stocks to provide the growth you need isn't the best bet. Rather, you'll need a truly diverse mix in your portfolio to grow your balance and protect yourself from market downturns.

The great thing about index funds is that they offer that diversity right off the bat. Going back to our previous example, an S&P fund will effectively mean that you're putting your money into 500 different companies. That's a great way to branch out.

3. You'll keep your fees to a minimum

All funds charge fees known as expense ratios that have the potential to eat away at your investment returns. But index funds are known to charge much lower fees than actively managed mutual funds.

The reason? Index funds don't employ seasoned fund managers to hand-pick investments. They simply track indexes that are already out there. Since there's less cost to operate an index fund, that savings gets passed on to you as an investor.

Put your savings to work

If you set aside $100 in a retirement plan today, it won't be worth $100 in 30 years from now because of inflation. But if you want to retain your buying power as a senior, then you'll need to invest your IRA or 401(k) in a manner that allows your savings to well outpace inflation. Index funds do a good job at achieving this goal, so if you're not sure how to invest for the long haul, they're a smart option to consider.

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