Many employees may not be aware of the investment choices they make when enrolling in a workplace 401(k) plan, according to a report. Traditional 401(k) contributions are made before taxes, allowing investment gains to grow tax-deferred, while Roth 401(k)s are funded after taxes, enabling tax-free growth and withdrawals. Despite the importance of selecting appropriate investments, only 31 percent of savers in Vanguard retirement plans actively choose their funds.
Understanding Target Date Funds and Their Limitations
For those who do not select their investments, employers often default them into target date funds, which adjust their asset allocation based on the anticipated retirement date. Vanguard reported that 96 percent of its retirement plans offered target date funds by the end of 2025, and 98 percent of employer-chosen default investments were also target date funds. While these funds can simplify investment strategies, financial advisors warn they may not always be the best option.
Matt Hylland, a financial planner at Arnold and Mote Wealth Management, notes that target date funds can be beneficial for individuals who prefer a hands-off approach to their 401(k) savings. However, he cautions that some funds may carry high fees, which can diminish overall returns. Vanguard’s average expense ratio for target date funds is 0.41 percent, but other funds may charge between 0.50 percent and 1 percent annually.
Investment Strategies for Retirement Savings
As retirement approaches, it’s generally advisable to shift investments from higher-risk stocks to more stable bonds to protect savings from market downturns. Target date funds automatically manage this transition, starting with a higher stock allocation and gradually becoming more conservative. However, Hylland emphasizes that these funds may limit stock exposure to as low as 30 percent, which may not align with some individuals’ investment goals, especially in terms of keeping up with inflation.
For those seeking a more aggressive investment strategy, alternatives such as S&P 500 index funds or a combination of stock and bond market funds may be more suitable. Additionally, some 401(k) plans provide both actively managed and passively managed target date funds, with the latter typically offering lower fees.
Regardless of the investment path chosen, it’s crucial for employees to remain informed about their 401(k) fund selections and associated fees to ensure their retirement savings align with their financial goals.
