If you’re offered a 401(k) plan through your employer, it could pay to take advantage of it. Many companies that sponsor 401(k)s also match employee contributions to some degree. And so participating in that plan could be your ticket to free money.
But the money you put into your 401(k) plan shouldn’t just sit in cash. Rather, the key is to invest it so it grows into a (much) larger sum over time. And in that regard, you have options.
You could invest your 401(k) in a target date fund, and if you were to go this route, you’d be in good company. Many savers rely on target date funds because they truly take the guesswork out of investing for long-term goals. But while there’s an upside to falling back on a target date fund for your 401(k), you may want to consider putting your money elsewhere.
Target date funds have their pitfalls
With a target date fund, you generally start off with more aggressive investments and then shift toward conservative ones as retirement nears. The upside? You don’t have to strain your brain thinking about how your 401(k) dollars are allocated because the fund you invest in will do that work for you.
If you prefer to be more of a hands-off investor, then you may find that a target date fund is an ideal choice for your 401(k). But if you’re willing to be a little more proactive on the road to growing wealth, then it actually pays to steer clear of target date funds for a couple of reasons.
First, target date funds tend to charge relatively high fees. Those fees could eat away at your returns through the years, leaving you with less money to fall back on in retirement.
Target date funds can also sometimes err on the side of being too conservative. That could result in limited growth in your 401(k).
A better alternative
If you’re not thrilled with the idea of investing your 401(k) in a target date fund, you might consider loading up on broad market index funds instead. Index funds are passively managed funds whose aim is to match the performance of the different benchmarks they’re tied to.
Like target date funds, index funds take a lot of the guesswork out of investing. That’s because you don’t get a say in what companies those funds consist of.
But one major benefit of index funds is that they tend to charge very low fees — lower than what you’ll commonly see with target date funds. And if you choose an index fund that tracks a benchmark with a strong history of solid returns, like the S&P 500, there’s a good chance you’ll end up happy with your 401(k)’s performance.
What’s the right call?
There’s nothing wrong with putting your 401(k) into a target date fund, especially if you’re a set-it-and-forget-it type of investor. But before you rely on a target date fund, consider the upside of branching out into index funds. You might enjoy stronger growth and lower fees — a winning combination.
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