Retirement planning can feel overwhelming. You're trying to guess how much money you need for an uncertain future, and then you have to make room for savings in your budget. And the decisions don't end there.
You also have to decide what you want to invest your money in. That's where a lot of savers make a potentially costly mistake.
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You pay a premium for simplicity
Many people feel uncomfortable choosing their own investments, which is a big reason target-date funds (TDFs) became so popular. These are investment bundles aimed at those who plan to retire in the specific year noted in the fund name.
As you near the target year, the fund's investments automatically become more conservative to protect your growing savings. It's a very hands-off way to invest, which is reassuring to many people who are worried about making the wrong choice when investing on their own.
But these aren't the most affordable investments to own. It's easy to miss because most of these funds charge expense ratios -- annual fees listed as a percentage of your assets that you pay to the fund manager.
The money comes right out of your account without you knowing, and it can add up quickly. If you have a TDF with a 1% expense ratio, you're paying $1 annually for every $100 invested in the fund. For someone with $500,000 in savings, you're giving away $5,000 each year in fees.
It is possible to find TDFs with lower fees, but to find them, you may have to do a bit of research. Look for the fund's prospectus. There should be a fee table there that gives its expense ratio. Compare a few options before deciding which one is right for you.
Is a target-date fund right for you?
Some people are willing to pay a little more in order to set-and-forget their retirement savings. There's nothing wrong with this as long as you understand the trade-offs. Paying higher fees means it'll take you a little longer to reach your savings goals.
If you want to keep your fees as low as possible, you may want to invest at least some of your savings in an index fund instead. This is also a bundle of stocks you purchase, designed to mimic the performance of a market index, such as the S&P 500. Because the stocks in these funds don't change as often, they're known for being affordable and still offering some diversification.
Just keep in mind that if you choose your own investments, you will have to adjust your asset allocation over time as your risk tolerance declines.
