Saving for retirement creates several challenges for today's workers. First, there is finding the cash to set aside without compromising financial security today. Then, deciding what to invest that money in so it can last as long as possible in retirement.
The latter issue can be just as intimidating as forgoing money in the present, especially for those with little experience investing. It's no wonder that hands-off investments have grown in popularity over the last few years. There's one type in particular that has really taken off -- but it's not right for everyone.
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As close to "set it and forget it" as it gets
Investment needs change over time. When you're young, you generally invest more in stocks because you can afford to take on greater risks for greater rewards. As you get older, you become more conservative to protect what you have.
But many workers don't understand how to adjust their asset allocation or how to diversify their savings to reduce the risk of loss.
Enter target-date funds. These are bundles of assets intended for workers who plan to retire in a specific year, as noted in the fund's name. The fund manager takes responsibility for choosing the investments in the fund and carefully managing your exposure to risk so you can earn a decent return without losing too much of what you already have. All you have to worry about is choosing the right fund and depositing money when possible.
The hands-off nature has seen target-date funds rise in popularity over the last several years. A little more than half of workers had all their 401(k) savings in a target-date fund in 2019, according to a recent Fidelity survey. That number has now risen to 61.5%.
It's an option to weigh, especially if you don't feel confident choosing investments on your own. But there are a few things to remember before going this route.
What to know before investing in a target-date fund
The first thing you'll have to decide is what target year to look at. This is supposed to match the year you plan to retire, so if you haven't thought about that yet, now is a good time to do so. The target year will always be in the name of the fund, so you'll know if it fits your time frame.
What's not as obvious is whether you're dealing with a "to" or a "through" target-date fund at first. "To" target-date funds are designed to reach their most conservative asset allocations in the target year. After they get there, they don't change anymore, while "through" target-date funds continue to grow more conservative even after the target year.
You can learn which type the fund is by looking at its prospectus. Information about the glide path tells you how the investments will change over time.
There isn't necessarily a right and wrong here. It's about how much risk you're comfortable with. Keep in mind that being too conservative can be risky as well if your investments aren't growing quickly enough to keep up with inflation.
While you're looking at the prospectus, you'll also want to check its fees. You'll often see this listed as an expense ratio -- a percentage of your assets in the fund that you pay to the manager annually. For example, if you have $1,000 in the fund and a 1% expense ratio, you'll pay $10 per year to the fund manager.
Target-date funds can be pricier than other types of investments, like index funds, which require less work from the fund manager. If keeping fees down is a top priority for you, consider placing some or all of your money in index funds instead.
Lastly, if your plans for retirement change, your initial target-date fund might no longer suit you. You might have to sell it off to invest in a new target-date fund or other investments, and there could be fees associated with this -- a risk you might be willing to take to avoid having to choose investments for yourself.
