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You might think that finding the money to contribute to your 401(k) is the hardest part of saving for retirement. But choosing the right investments can also be challenging.
For this reason, many 401(k) savers take the easy way out and let their money land in a target date fund. A good 61% of 401(k) plan participants, in fact, had their money in a target date fund last year, according to Vanguard’s preview of its latest How America Saves report.
But while target date funds can be an effective solution for many savers, if you rely on one, you may end up sacrificing growth potential in your 401(k). That’s something you might regret later.
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Why a target date fund could let you down
Target date funds are designed to be a one-size-fits-most solution. You select a fund based on your expected retirement year, and your assets are shifted automatically based on how close you are to that date.
Target date funds certainly make saving for retirement easy. The problem, though, is that not all savers have the same goals, risk tolerance, or financial situation.
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It’s common for target date funds to become conservative as retirement approaches. To be fair, that’s what they’re supposed to do.
But when those funds get too conservative, they can limit growth potential. That could become a problem if it leaves your 401(k) plan underfunded.
Target date funds also don’t account for investments you might have outside of your 401(k). If you have conservative assets elsewhere, you could risk a retirement savings shortfall on a whole.
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Target date funds are notorious for charging higher fees. Those fees could erode your returns and leave you with a 401(k) balance you’re less than pleased with.
Alternative 401(k) investments to consider
If you’re willing to take a more hands-on approach to your 401(k), you may find that you’re able to score higher returns and reduce your fees at the same time.
Many 401(k) plans provide access to low-cost index funds that track major benchmarks such as the S&P 500. Leaning on these funds could help your money grow at a stronger pace without having to pay for active fund management.
You can also mix and match funds in your 401(k) to get exposure to different corners of the market. For example, if you’re on the younger side and have a greater tolerance for risk, you may want to choose funds that invest in international stocks or small-cap companies.
This doesn’t mean that target date funds are a bad choice for savers universally. They tend to do a great job of promoting portfolio diversification.
Rather, it’s that if you don’t look outside of a target date fund, you may end up with sluggish returns that limit your spending power in retirement. Taking the time to review your 401(k)’s investment choices could push you to choose more optimal investments that help you meet your retirement goals.
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