A survey conducted last year by the Employee Benefit Research Institute polled current retirees and asked them what advice they would give their younger selves about planning for retirement. A vast majority, about 70%, said they wish they had started earlier.
Time is a huge ally for retirement savers as it allows investments to grow and compound -- earning returns on top of returns -- so that your money makes money.
Now assuming you have some form of primary savings vehicle like a 401(k) or employer-sponsored plan, and perhaps a savings account or individual retirement account (IRA), there is one other easy retirement savings vehicle that you should consider: a target date retirement fund. Target date funds are an easy and effective way to supplement your retirement savings.
What are target date funds?
Most of the major asset management firms like BlackRock, State Street, JPMorgan Chase, T. Rowe Price, Vanguard and Fidelity offer target date funds. You've probably seen them in your employer-sponsored plan, too.
They are popular among retirement savers because they are essentially self-contained retirement portfolios with a mix of stocks and fixed income investments that shift over time based on how far away retirement is. In short, target date funds are developed for the year you plan to retire. Vanguard, for example, has a roster of target retirement funds that range from a 2025 target retirement date to a 2070 target retirement date, with everything in between in five-year intervals.
Image source: Getty Images.
So, say you are 40 and you plan to retire in 25 or so years. You would invest in the Vanguard Target Retirement 2050 Fund based on the notion that you would retire around 2050. If you invested in it now, it would be about 90% in stocks and roughly 10% in bonds and fixed income because the target date is 27 years off. As you get closer, the mix becomes gradually more conservative. By 2050, it will reflect the asset mix of the Vanguard Target Retirement Income Fund, which is about 70% fixed income and 30% stocks.
This particular target fund is made up of five different Vanguard funds: the Vanguard Total Stock Market Index Fund (currently 55%), the Vanguard Total International Stock Index Fund (36%), the Vanguard Total Bond Market II Index Fund (7%), the Vanguard Total International Bond II Index Fund (3%), and the Vanguard Short-Term Inflation-Protected Securities (1%). There are exchange-traded fund (ETF) versions of most of these funds, but in this case, you can't trade them, as the funds within the target date funds are managed and re-allocated by Vanguard.
Most target date funds are built on the same concept, but many consist of more funds than this. The BlackRock LifePath Index 2050 Fund, for example, is made up of seven different funds, while others consist of 10 or more.
Why they make sense
These are great investments for people who want to supplement their retirement savings without having to worry much about short-term market fluctuations or portfolio management. It is all done for you in a way that minimizes risk.
One thing to look for when assessing the various target date funds is the glide path of the fund, which means the path along which the allocation shifts. Some might be slightly more aggressive, with a higher percentage of stocks to fixed-income investments over time, while others may be more conservative.
Another factor to consider is expense. Some can be more expensive, but the reason I like the Vanguard funds is they are among the cheapest on the market with an expense ratio of around 0.08%.
Also, keep in mind that these are not for everyone. They are built to be relatively safe, steady vehicles that minimize risk and don't require much attention. They may be better suited for more novice investors, those who are risk-averse, or those who want some downside protection in a portfolio.
But the returns are pretty decent. The Vanguard 2050 fund, for example, is up 12.4% year to date and 14.6% over the past year as of June 30. Also, it has a 10-year annualized return of 8.8%.
So, if you invested $5,000 in this target fund and contributed $100 per month with, say, an 8% annual return, you would have about $160,000 by 2050. That alone is not enough to retire on, but when combined with a 401(k) or IRA, it would provide an excellent boost with very little effort and not a lot of worry about what the markets are doing.
Of course, the sooner you start, the better off you will be in the long run. Because if you start even further away from retirement and did a 2060 target date fund, for example, you'd have about $367,000 with the same inputs as above.
