Many people have access to a 401(k) plan through an employer. And if you’re one of them, it generally pays to enroll.
The upside of participating in a 401(k) is getting access to employer matching dollars. Plus, contributions are seamless. Because they’re taken as up-front payroll deductions, there’s little work to do once you enroll.
But that doesn’t mean you don’t have to put any effort into your 401(k). While you don’t have to actively write out a check every month, you do need to make sure your money is invested appropriately. And to that end, you might be inclined to put your money into a target date fund. Whether that’s a good idea, though, is up for debate.
How target date funds work
Target date funds are set up to invest your money more aggressively early on and then shift toward more conservative investments as your designated milestone arrives. In the case of a 401(k), a target date fund would have you loading up on more aggressive investments ahead of retirement, like stocks, and then shifting toward safer ones, like bonds, as retirement nears.
When you first open a 401(k), you’ll commonly be automatically enrolled in a target date fund. And from there, it will be on you to choose another home for your money or leave it where it is.
In fact, in a recent Vanguard report, 81% of all 401(k) plan participants used target date funds. And 69% had their entire retirement account invested in such a fund. But there are pitfalls to relying on these funds to meet your retirement savings goals.
Target date funds could lead you astray
While target date funds are touted for taking the guesswork out of investing, they have a tendency to err on the side of being too conservative. That could, in turn, leave you with a savings shortfall once retirement kicks off.
Plus, target date funds tend to charge high fees. Those could eat away at your returns through the years, shrinking your nest egg in the process.
An alternative worth exploring
It’s easy to see the appeal of target date funds. In theory, they allow you to meet your savings goals without having to do a lot of work.
But if that’s a route you’d like to take, there could be a better solution: index funds. These are commonly found in 401(k)s, and the benefit to owning them is that they often charge lower fees than target date funds. And depending on the funds you choose, the investments at hand might better lend themselves to growth in your retirement plan.
Another option is to split your savings between a target date and index funds. That’s a good choice to consider if you’re a more risk-averse investor.
Know how you’re invested
No matter how you choose to invest the money in your 401(k), don’t make the mistake of opening an account and not following up on where the cash lands. Chances are, it’ll end up in a target date fund. And while that’s not automatically a bad thing, it’s important to understand how your contributions are being invested and whether that option is likely to make your long-term goals attainable.
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