It's important to save for retirement so you have income to fall back on in addition to whatever benefit Social Security pays you. But it's not enough to just stick money into a retirement plan. You also need to figure out how to invest your savings.
For many people with 401(k) plans, target date funds are a popular choice. A target date fund is a fund that's designed to adjust your risk profile based on how far or close you are to the milestone you're saving for. In the context of retirement savings, a target date fund will invest your assets accordingly based on your estimated retirement date.
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Investing in a target date fund is perhaps the simplest route you could take in the context of building a retirement nest egg. But that doesn't automatically make it the best route.
The problem with target date funds
Although target date funds make investing for retirement easy, there are a couple of problems. First, these funds have a tendency to err on the side of investing too conservatively.
If you're someone who's very risk-averse, this might seem like a good thing. But you should know that investing too conservatively through the years could lead to a retirement plan balance that falls short of meeting your savings goal.
Another issue with target date funds is that their fees tend to be high. Those could eat away at your returns through the years, leaving you with less income by the time retirement arrives.
In a recent letter to investors, BlackRock CEO Larry Fink was quick to talk up the benefits of target date funds. He said, "They only require people to make one decision: What year do they expect to retire? Once people choose their 'target date,' the fund automatically adjusts their portfolio, shifting from higher-return equities to less risky bonds as retirement approaches."
But Fink also acknowledged, "There are limits to what something like a target date fund can do."
Another option to consider for your retirement plan
If you don't consider yourself a particularly savvy investor and you don't feel equipped to hand-pick stocks for your portfolio, then you may be inclined to fall back on a target date fund. And if you have 401(k) plan, you generally can't hand-pick stocks anyway. That's usually only an option in an IRA.
But rather than assume that a target date fund is your best bet, consider putting your money into broad market index funds. The nice thing about index funds is that they're passively managed, so the fees you pay are likely to be low. But also, with something like an S&P 500 index fund, you might score a higher return in your portfolio, thereby allowing you to have enough money to enjoy the retirement lifestyle you want.
Of course, it's possible to put some of your money into a target date fund and invest elsewhere as well. This could be a reasonable compromise if you're someone who really has limited tolerance for risk. But otherwise, consider looking outside of target date funds for your long-term savings so you don't wind up disappointed in the amount you've accumulated.
