Target-date funds make good choice for novice

The Baltimore Sun

You may not have a lot of cash to invest and you probably can't afford a professional to decide where those dollars should go.

With access to a 401(k) for the first time, new hires entering the work force may be at a loss when it comes to investing. What to do?

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 off your portfolio.

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 might 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.

Carolyn Bigda writes for Tribune Media Services.

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