There are certain benefits to saving for retirement in a 401(k). For one thing, 401(k)s get funded automatically via payroll deductions, so if you have access to one of these plans and sign up, you may be more likely to stay on track with your savings goals.
Also, 401(k) plans often come with some type of employer match. So in that case, all you need to do is put in some money out of your own paycheck, and bam -- you're getting free cash in your account from your employer.
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But if you're going to contribute to a 401(k), it's important to try to make the most of your money. In fact, your goal should be to try to snag the highest possible return in your account while avoiding costly fees. But if you stick to one popular 401(k) investment, you might set yourself back big time.
Are you going all in on target date funds?
One downside of saving for retirement in a 401(k) is that you generally can't put your money into individual stocks. Rather, you're limited to different funds.
One popular type of fund you'll usually see in 401(k)s is a target date fund. These funds can be an easy means of saving for retirement, because what they do is adjust your risk profile based on where you are in your savings window.
When you're further away from retirement, you'll be invested more aggressively. But as retirement nears, you'll be shifted into assets that are known to be more stable.
A target date fund is a great "set it and forget it" type of 401(k) investment. The problem, though, is that target date funds are notorious for charging high fees that can eat away at your returns over time.
Another issue? Some target date funds tend to err on the side of being overly conservative -- even early on in your savings window, when you have an opportunity to get more aggressive because retirement is pretty far off. That could lead to a lower ending 401(k) balance.
Recent data from Fidelity found that as of the fourth quarter of 2023, a little more than 63% of 401(k) participants had all of their retirement savings in a target date fund. And among Gen Z workers, that percentage soared to over 84%. But this means that a lot of savers are at risk of falling short of their 401(k) goals.
It pays to branch out
You may be inclined to put all of your 401(k) savings into a target date fund since it's a pretty easy, low-key approach to building a nest egg. But know that if you go this route, you may end up disappointed with your results.
This doesn't mean you need to completely stay out of target date funds. But it could also pay to put a good chunk of your 401(k) into index funds.
The nice thing about index funds is that they're passively managed. They simply aim to track and match the performance of existing market indexes. Because of this, their fees tend to be reasonable. And index funds have a strong history of outperforming actively managed mutual funds -- another popular investing option you'll find in 401(k)s, and one that, like target date funds, tends to come with higher fees.
If you're truly a hands-off investor, you may be inclined to put your 401(k) into a target date fund and call it a day. But do recognize the downside of falling back on target date funds before making that decision.
