Key Points
The way you invest your 401(k) could help determine how much money you retire with.
If you don't choose investments for your 401(k), your money will probably land in a target date fund.
These funds have several drawbacks you should know about.
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If you're making steady contributions to your employer's 401(k) plan, you're doing a very good thing for your retirement.
Social Security will only replace about 40% of your pre-retirement paycheck if you earn an average wage. Most seniors need a lot more money than that to cover all of their expenses, so it's important that you build up retirement savings on top of those benefits.
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But while regularly funding your 401(k) is a step in the right direction, it's not enough. You also need to make sure your 401(k) is working for you. And that means avoiding this key mistake.
Don't get stuck with the wrong investment
If you put money into your employer's 401(k) without specifically choosing investments, there's a good chance your money will land in a target date fund. These funds simplify retirement investing by putting your money into riskier assets when you're younger, and then gradually shifting into more stable assets as retirement nears.
The problem with target date funds is twofold. First, even though these funds are designed to adjust your risk profile based on your age, they generally tend to err on the side of investing too conservatively overall. That could lead to lower returns that limit the amount of money you're able to accumulate in time for retirement.
Also, target date funds tend to come with expensive fees. Those fees could eat into your returns over time, costing you money.
Review your 401(k)'s investment choices carefully
While there are plenty of 401(k) savers who fall back on target date funds, that's not necessarily the right choice for you. Before you settle for one, take a look at the different options your 401(k) plan offers.
You may find that your 401(k), for example, offers some low-cost index funds you can put your money into. If you buy shares of an S&P 500 index fund, you'll get exposure to hundreds of large, established businesses across a range of industries.
And while having all or most of your 401(k) in an S&P 500 fund isn't necessarily the best bet during or close to retirement, you can always shift into safer assets as that milestone nears. You don't need a target date fund to do it for you.
The purpose of funding a 401(k) is to set yourself up for a financially secure retirement. But the wrong investments could get in the way of that goal. Rather than run that risk, explore your plan's investment choices, and don't assume that a target date fund is the best place to put your money.
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