Increasingly, workers trying to save for retirement in 401(k) plans are offered target-date funds. In some cases, such funds are automatically chosen for them, along with minimum contribution levels.
Such “opt-out” procedures (the employee has to choose to change these settings) are used to help people make better choices, or any choice at all. Too often, workers fail to sign up for retirement savings plans when they are young, or they put far too much money into extremely conservative investments.
So what is a target-date fund? Think of it as a pension-in-a-box. Rather than hiring a financial advisor to help you come up with a personalized investment plan, target-date funds asked you to make a single decision: What year do you expect to retire?
Once they know that, you are put into the plan with an end date nearest your choice. If you say, “about 2035,” then you are likely to be in a fund with a name such as “Target Fund 2035.”
Underneath, the fund owns a broad array of investments based on that target year. If it’s decades away, expect more stocks than bonds. If you pick a date just five years ahead, it’s likely to be much more conservatively invested.
But even the fund dated decades hence will protect you. As the years pass, its managers will be moving your money steadily into more conservative positions. That way, if the stock market declines sharply just before your retirement date you will still be able to quit work.
There are some caveats to consider. First of all, be sure that the target-date fund you choose is invested in the way you expect. A load of expensive active mutual funds, for instance, is not likely to give you a good long-term return.
Likewise, beware the urge to quit investing altogether right on your retirement day. You are likely to live a long time in retirement, and longer if you decide to retire early. Some target-date funds have begun to take a “fuzzy” approach to their ending date, even holding stocks for longer and selling off opportunistically in the years before and after the end year of the fund.
Finally, be mindful of the fact that all funds have costs. A well-managed portfolio need not cost you a lot of money, and rebalancing can be done using software online, if you feel confident that you can make choices as intelligently as an advisor might.
Keeping more money in your pocket today means it will compound on your behalf into the future. Along with low-cost index funds, compounding is a powerful force and a clear path toward the kind of steady gains you need to build retirement wealth.