What are target-date funds, and are they a good choice for my 401(k) investments?

2 min read

If you are saving for retirement, you may have heard of target-date funds as a simple and convenient option for your 401(k) investments. Target-date funds are mutual funds that automatically adjust their asset allocation mix of stocks and bonds as you get closer to your retirement date. You can pick a fund with a target date that matches your expected retirement year and let the fund do the rest.

However, target-date funds are not ideal for everyone. You should be aware of several drawbacks to investing in these funds before you put your hard-earned money into them. Here are some reasons why there may be better choices than target-date funds for your 401(k) investments.

High Fees

One of the most significant disadvantages of target-date funds is that they charge higher fees than other mutual funds. According to Morningstar, the average expense ratio for target-date funds was 0.48% in 2020, compared to 0.13% for index funds and 0.66% for actively managed funds. While this may seem small, these fees can affect your returns and reduce your retirement savings.

Lack of Customization

Another drawback of target-date funds is their need to consider your risk tolerance, goals, and circumstances. Target-date funds use a generic formula to determine how much risk to take and how to allocate your assets based on your age and retirement date. However, this formula may not suit your personal preferences and needs.

For instance, some target-date funds may be too aggressive or too conservative for your liking. Some funds may hold too much or too little in stocks or bonds depending on your risk appetite and expected income sources in retirement. Some funds may also invest in asset classes that you do not want or need, such as international stocks, commodities, or real estate.

Moreover, target-date funds do not consider your other investments outside your 401(k) plan, such as IRAs, taxable accounts, pensions, or Social Security benefits.

Better Alternatives

Instead of relying on a target-date fund for your 401(k) investments, you may be better off managing your asset allocation and choosing low-cost index funds that match your risk profile and goals. This way, you can have more control over your portfolio and save on fees.

If you are not confident about managing your investments, Xillion's 401(k) optimizer helps you select the best funds for your 401(k) plan based on your preferences and objectives. It analyzes your current 401(k) holdings and suggests how to improve them by eliminating high-fee or poorly performing funds and replacing them with better alternatives. You can also use Xillion's 401(k) Optimizer to monitor your portfolio and get alerts when it needs rebalancing or updating.

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