It's an unfortunate but known fact that many Americans are nearing retirement without adequate savings. Recent data from Northwestern Mutual shows that the average Gen Xer has a savings balance of $108,600, while the typical baby boomer has $120,300. These aren't particularly large numbers, and savers in both age groups may have limited time to catch up on building nest eggs.
One potential barrier to building retirement savings may be that some people find the idea of investing their money daunting. And to that end, many 401(k) plans offer a reasonable solution -- the target date fund.
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Target date funds are funds that automatically adjust your risk profile based on where you are in your savings window. Let's say you decide to put money into a target date fund and list 2054 as your anticipated retirement date. Over time, your fund will automatically shift you into safer investments as your workforce exit nears so you're not taking on undue risk.
Target date funds also don't require you to hand-pick stocks or sink a lot of time into investment research. You pretty much just designate a retirement date and call it a day.
Recent research from Vanguard finds that target date funds could be conducive to increasing retirement readiness among workers. But there are a couple of pitfalls you should know about if you're thinking of going all-in on a target date fund.
You could face high fees
The more fees you pay in the course of investing, the more your returns are eroded. Now the problem with 401(k) plans is that they generally don't allow you to invest in individual stocks. Rather, you're usually limited to an assortment of funds, including target date funds.
But the fees target date funds charge can be substantial. So if your goal is to take the guesswork out of investing for retirement, you may want to see if your 401(k) has an S&P 500 index fund you can put your money into instead. Because index funds are passively managed, their fees tend to be reasonable. And there's really not much work to do on your part, since an S&P 500 index fund will simply aim to match the performance of the index itself.
Now one thing you will need to be aware of is that if you put your 401(k) into an S&P 500 index fund, you'll probably want to shift some of your money into more conservative assets as retirement nears. But that's something to look at doing when you're within five to 10 years of exiting the workforce. If you're in your 30s or 40s, you could put your money into an S&P 500 index fund, sit back, and do nothing for quite a while.
You could lose out on higher returns with a target date fund
The nice thing about target date funds is that you'll be shifted into more age-appropriate investments as retirement gets close. But sometimes, target date funds tend to err on the side of being too conservative. The result? Lower returns in your 401(k).
Now one thing you could do is put a portion of your savings into a target date fund and maintain a more aggressive portfolio outside of it. But if you're choosing a target date fund for the simplicity, that sort of negates that purpose.
All told, a target date fund could be a good choice for your retirement savings. But read up on target date funds before making that call so you know what you're signing up for.
