Target-date funds in your 401(k): A beginner's guide to retirement savings

Saving for retirement can sometimes feel daunting. You may need to consider factors like risk tolerance, investment time horizon, and choosing the right assets. Target-date funds, offered by many 401(k) plans, can help simplify the process by offering a one-stop solution for retirement savings. This guide is intended to equip you with the knowledge to decide if a target-date fund is right for you and explore key factors to consider when choosing one.

What is a target-date fund?

A target-date fund (also known as a lifecycle fund) is a type of investment designed with a specific retirement year in mind. These funds can hold a mix of assets, typically stocks, bonds, and sometimes cash equivalents. The asset allocation—or the percentage of each asset class—is designed to become more conservative (i.e., less risky) as you approach your target retirement date.

How do target-date funds work?

When investors select a target-date fund, they are instructed to choose the fund with a target date closest to their expected retirement year. For example, if you plan to retire in 2050, you might choose a "Target Date 2050 Fund." ​​Generally, fund allocation is more aggressive (i.e., may have a higher percentage of stocks) for investors with longer time horizons and becomes more conservative (i.e., may have a higher percentage of bonds) as the target date approaches.

Here's how target-date funds are intended to work:

• Automatic rebalancing: The fund manager seeks to rebalance the asset allocation over time. As you get closer to retirement, the fund is intended to become more conservative, reducing your exposure to potentially volatile stocks and increasing your holdings in more conservative bonds as you get closer to your anticipated retirement date.

• Diversification*: By holding a mix of assets, target-date funds help offer built-in diversification, a key principle of investing. This helps spread your risk and potentially smooth out market fluctuations.

• Convenience: Target-date funds offer an "all-in-one" approach. You are instructed to choose a fund with a target date close to your planned retirement year, and the fund manager takes care of the rebalancing, as discussed above.

*Diversification does not ensure a profit or protect against loss.

Are target-date funds right for you?

Target-date funds may be a good option for many 401(k) participants, especially those who:

• Are new to investing: They can offer a simple, more hands-off approach to retirement savings.

• Don't have the time or expertise to actively manage their investments: The fund manager does the heavy lifting, and the asset allocation is designed to rebalance over time.

• Have a long time horizon until retirement: The long-term focus of target-date funds may align well with long-term retirement goals. For those who are late in their retirement savings journey, a more aggressive investment approach may be necessary to reach their goals, though each individual's circumstances may vary.

However, target-date funds may not be ideal for everyone. Here are some things to consider:

• Risk tolerance: If you have a high-risk tolerance, you might prefer a more aggressive asset allocation than the one selected based on your anticipated retirement year alone.

• Investment goals: If you have specific retirement goals or investment preferences, target-date funds may not offer the level of customization you desire.

• Fees: Some target-date fund families may be more expensive than building your own portfolio. Compare the expense ratios of different target-date funds offered in your 401(k) plan. Generally, lower expense ratios mean that you can keep more of your returns.

Potential considerations when choosing a target-date fund

Here are some key differentiators between target-date funds to consider when making your choice:

• Target date: Generally, you are instructed to choose a fund with a target date closest to your planned retirement year.

• Asset allocation: Understand the fund's underlying asset allocation. This will help give you a sense of the risk profile. Generally, younger investors may want to consider a higher allocation to stocks, while older investors may want to consider allocation to bonds. However, all investors should consider their personal circumstances and risk profiles (among other considerations) prior to deciding what allocation may be appropriate for them.

• Underlying investments: Some target-date funds invest in actively managed funds, while others use passively managed index funds. Actively managed funds typically have higher fees. Some target-date funds combine a mix of both actively and passively managed funds.

• Expenses: Compare the expense ratios of different target-date funds. A lower expense ratio generally means that you can keep more of your returns.

Target-date funds: Beyond the basics

While target-date funds may be a helpful starting point, some investors might want to explore additional options:

• Multiple target-date funds: If you feel that one target-date fund doesn’t target your desired asset allocation, you can allocate your contributions across multiple target-date funds to create a more customized asset allocation.

• Asset Allocation Beyond Target-Date Funds: If you have a strong risk tolerance or specific investment goals, you might consider allocating your contributions to other funds within your 401(k) investment options in addition to, or aside from, your target-date fund.

• Consulting a Financial Advisor: For complex situations or personalized advice, consider consulting a financial advisor who can help you develop a comprehensive retirement savings plan.

Target-date funds can help offer a convenient and effective way to save for retirement in your 401(k) plan. By understanding how they work—and considering the factors discussed above—you can make a more informed decision if a target-date fund is right for you and choose the right option based on your individual circumstances.

For many, retirement planning is a marathon, not a sprint. Start early, stay consistent, and consider seeking professional advice if needed. With the right approach, you can aim to build a secure financial future for your golden years.