This method saves you time and is great for passive investors.
- Investing in individual stocks takes time and can be challenging.
- If you’d prefer something simpler, target-date funds are an alternative option.
- A target-date fund is designed for a specific retirement year, and the asset allocation changes as you get closer to retirement.
As important as investing is, it can also be a time-consuming process. If you’re investing in individual stocks, you’ll most likely need to find at least 25 good ones to build a diversified portfolio. You’ll need to check in on your portfolio somewhat regularly, to make sure there aren’t any issues. As you get closer to retirement, you’ll need to put more money into conservative assets, like bonds.
It can start to feel like another job. In addition to the time involved, stock picking can be stressful. It’s not always easy to figure out which companies are worth an investment.
But you don’t need to choose your own individual stocks when investing. There’s another option that will do the heavy lifting for you, from now until retirement.
Why target-date funds make investing easier
If investing in individual stocks isn’t for you, consider picking out a target-date fund instead and investing in that. Target-date funds are a type of mutual fund designed for a specific retirement year. For example, if you want to retire in 2050, you’d choose a 2050 target-date fund.
Like other investment funds, target-date funds contain a pool of investor money. That money is invested in securities, most often stocks and bonds. What makes target-date funds different is that they’re managed with the retirement year in mind. The asset allocation changes according to what’s known as the fund’s glide path.
A target-date fund might start with a 90:10 ratio of stocks to bonds. That way, it maximizes growth while you’re young. When you have 25 years until retirement, it could gradually allocate more toward bonds, reaching a 60:40 ratio of stocks to bonds on the retirement date. This is just one example, and glide paths vary. It’s important to choose a fund with a glide path that works for you.
The advantage for you is that this is a hands-off way to invest. After you’ve chosen a target-date fund, all you need to do is invest regularly. Financial advisors often recommend these funds for the simplicity involved. For one notable example, financial guru Ramit Sethi recommends target-date funds to his own family.
Do target-date funds have any drawbacks?
Target-date funds aren’t perfect, with two notable downsides.
First, some target-date funds have high expense ratios (management fees). If you’re paying a fee of 0.5% or more, that significantly constrains how much your portfolio grows. Aim for an expense ratio of no more than 0.1% to 0.2%.
Another issue is that target-date funds generally don’t perform well for retired investors. Asset allocation tends to become highly conservative, with stocks sometimes making up 20% or less of your portfolio. Even though it might seem like you’re playing it safe this way, you’re actually missing out on growth. That means you won’t be able to safely withdraw as much.
How to invest in a target-date fund
You can invest in a target-date fund from any investment account, including retirement accounts. Options include:
If you already have any of these accounts, see what target-date funds are available. For example, if you have a 401(k) at work or an IRA with Charles Schwab, start there.
If you don’t have an investment account, or your account doesn’t have any target-date funds you like, shop around to find one you like. Check out some of the best stock brokers and see what fund options they have.
When choosing a target-date fund, there are a few things to look at. The first is that it matches your desired retirement year. You’ll also want to look at the fees, the asset allocation, and the level of risk and reward. Keep in mind that a higher-risk fund isn’t necessarily a bad thing. That just means it will be more heavily weighted toward stocks. If you’re decades from retirement, that’s good.
Target-date funds are one of the simplest passive investing options out there, and they perform well, as long as you pick one with reasonable fees. Once you’ve found one, it can take much of the worry and work out of investing.
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