With access to a 401(k) for the first time, new hires entering the workforce may be at a loss when it comes to investing.
- Banking on a home: Using equity as a retirement nest egg can be difficult
- Amid volatility, investors may not be insulated
- Retail funds falling out of favor in some 401(k)'s
- The savings game
- The Leckey file
- Getting started
- Spending smart
- Can they do that?
- Taking stock
- Latin American funds could burn late-arriving investors
- The week ahead
Fewer new workers can count on a pension to fund their retirement, and Social Security may not be able to either. But companies are beginning to embrace one option that makes investing easy for employees: target-date retirement funds (also known as life-cycle funds).
Here's why these funds often are a good fit for novice investors:
-- Get instant diversification
Target-date funds invest in a mix of stock and bond funds based upon your planned retirement date. They typically hold from five to 15 separate funds, according to Greg Carlson, a mutual fund analyst for Morningstar Inc. You receive exposure to bonds, U.S. stocks of big and small companies and international stocks--all essential to a well-rounded portfolio.
Even if you're investing in a target-date fund on your own in an individual retirement account, you don't always need to pony up the minimum initial investment for each fund. In fact, sign up to make automatic monthly contributions and you may need next to nothing. At T. Rowe Price, for example, you can invest in the fund company's target-date funds for as little as $50 a month.
-- A pro decides the allocation
Target-date funds don't stop with diversification: The fund sets the appropriate mix of stocks and bonds--called the asset allocation--for you based on your retirement date. And over time, the mix gradually becomes more conservative as you move closer to kicking back.
The help often is needed. A study last summer by the Employee Benefit Research Institute found that 18 percent of young workers who participated in a 401(k) held no stocks, even though historically stocks beat out bond returns over long stretches of time--the kind of time young investors have.
-- No need to rebalance
Even if you have a cool enough head to pick the right asset allocation, you may not remember to rebalance the portfolio regularly. Here again, target-date funds do it automatically, helping prevent one asset class from becoming too large or too small and throwing your portfolio off-kilter.
-- It's the default option in many 401(k)'s
Finally, a federal law passed last year gives companies greater license to automatically enroll employees in a 401(k) or other retirement plan. And more companies are looking to target-date funds as the default option. Despite their simplicity, target-date funds do require some of your attention. If you're invested in one or would like to get started, keep these points in mind:
-- The average expense ratio for target-date funds with maturities in 2030 or later is 1.3 percent, according to Morningstar. Ideally, you want to pick a fund that charges the average or lower. As with all funds, the lower the fees, the more you get to keep of the fund's return.
-- A target-date fund may not always invest as aggressively for the year listed. "A fund company may invest a little conservatively to ensure your money is there when it's time to retire," said Jacob Gold, a certified financial planner in Phoenix.
In other words, compare the asset allocation of several target-date funds near the time you want to retire, opting for the one that best matches your risk tolerance.
-- Keep in mind that a target-date fund is only as good as the funds it invests in. "Ideally, you want to choose a target-date fund from a company that has investing expertise across a broad range of categories," said Morningstar's Carlson. "There aren't a lot of companies that have it."
You can check out how those underlying funds stack up at Morningstar.com. If you don't like what you see, you always can pick a low-cost index fund to start with instead.
And no matter what, you can't go wrong with starting to save in your 20s.
E-mail Carolyn Bigda at firstname.lastname@example.org.