For many people, contributing to a 401(k) is one of the easiest parts of retirement planning. All you need to do is tell your employer the percentage of your salary or a specific dollar amount you want to fund your retirement account with, and that amount will be deducted from your paychecks. You don’t have to worry about remembering to transfer that money yourself.
Not only are 401(k) plans easy to fund, but many savers find investing in them easy. That’s because many 401(k)s put contributions into a target date fund based on an expected retirement year automatically.
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Target date funds are basically a “set-it-and-forget-it” investment. The fund will automatically adjust your asset allocation based on where you are in your retirement journey.
But a target date fund might also set you back on meeting your retirement savings goals. So you may want to rethink this approach to building wealth for your senior years.
The problem with target date funds
Target date funds are designed to gradually reduce investment risk as retirement nears. And that’s a good thing in theory. The problem is that these funds often become conservative too soon or err on the side of being too conservative in general.
As retirement approaches, many target date funds significantly reduce stock exposure to limit volatility. While that may sound like the safest bet, going too light on stocks could limit your returns, leaving you with less buying power once you start tapping your nest egg.
Another issue with target date funds is that some charge higher investment fees, known as expense ratios. Those fees might seem small on an annual basis. But over several decades, they can significantly erode your returns. Plus, some target date funds maintain large cash allocations that can also limit growth.
Another option worth looking at
You might think a target date fund is your easiest investment option if you have a 401(k). But an S&P 500 (^GSPC 1.24%) index fund may be just as easy — without the same costly fees and limited returns.
Or, there may be other funds within your 401(k) that are better aligned with your risk tolerance and retirement savings goals. So before you fall back on a target date fund, see what options your plan offers.
There’s nothing wrong with being a more hands-off investor. But relying on a target date fund could leave you disappointed in the 401(k) balance you ultimately bring into retirement.
Maurie Backman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
