It’s important to consistently sock money away in a retirement savings plan. The benefits you receive from Social Security may not be nearly generous enough to cover your senior living costs in full. And so you’ll need a nest egg to tap to help ensure that you don’t end up struggling financially.
The money in your retirement plan shouldn’t just sit in cash, though. Inflation will erode the value of your savings over time if your money isn’t generating solid returns. That’s why you need to invest the money you’re socking away for retirement — even if that means taking on some risk and having to make tough choices.
One specific retirement investment, however, takes a lot of the guesswork out of choosing where to put your money. And it’s an option you’ll commonly have access to in a 401(k) plan. But while it may be a popular option, it’s not necessarily the best choice for you.
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Should you fall back on a target date fund?
If you sign up for your employer’s 401(k) plan and don’t decide how to invest your money, you’ll generally wind up invested in your plan’s default option. And most of the time, that default option will be a target date fund.
Target date funds invest your money based on certain milestones, and they adjust your risk profile as those milestones near. So in the case of a 401(k), a target date fund will generally have you invested in riskier assets earlier on in your savings window but then shift you over to less volatile assets as retirement gets closer.
The upside of target date funds? You don’t really have to do much brainwork to invest your retirement savings. That’s a good thing if you’re nervous about choosing the wrong assets.
But target date funds also have their drawbacks. For one thing, they tend to charge high fees (known as expense ratios) that can eat away at your returns. They also, in some cases, tend to err on the side of being too conservative. That may be a positive thing if you’re particularly risk-averse. But it could mean missing out on higher returns and winding up with less money to spend during your senior years.
What’s the right move?
If you’re really not confident in yourself as an investor, then target date funds are a reasonable option to fall back on. But if you know a thing or two about investing, then it pays to put that knowledge to work and choose your own funds for your 401(k).
Furthermore, if you have an IRA, you have even more choices as far as investing goes. IRAs let you put money into individual stocks, so you can truly customize your portfolio as you see fit.
With target date funds, you don’t really get a say as to how your savings are invested. If that sounds like a good thing, it’s a sign that target date funds may be the best choice for you. But if you’d rather take a more active approach to investing, then it pays to steer clear of target date funds even if you are tempted to take the easy way out.
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