Putting The Fun In Target Date Funds

Putting The Fun In Target Date Funds

To the layperson, investors are usually seen as a knowledgeable and busy bunch. They’re not wrong. The best investors are active, managing their portfolios regularly and making small improvements as they go along. But investing can be for everyone – not just stock market gurus and Wall Street fanatics. So how can more casual investors put their money towards good use without spending all of their time as well as finances? That’s where target date funds come in handy. Designed for the hands-off investor, they’re a great way to invest your money without investing your time.

What are Target Date Funds?

Target date funds are a basket of funds designed for investors who want an easy retirement option. Like their name, these funds are organized by date. Investors can choose which fund they want based on the corresponding year in which they hope to retire. For example, a 25 year-old may choose a 2055 target-date fund, when they’ll be 65 years old. So how exactly do the funds change over time? Like with most investment strategies, it’s all about intelligently handling market risk. As the investor gets older, the fund automatically rebalances to become more conservative over time. The fund that a 25 year-old purchases will be allocated towards safer investments when that consumer is 40, and even safer when they’re 60. Many investors who want to save for retirement are unable, uninterested or uncertain of their ability to choose their own funds. Creating a solid mix of funds can require hours of research, and staying on top of their allocation can be a chore even for the most seasoned financial professional. That’s why target-date funds are so popular; they already have the funds and investment strategy chosen for you.

Target Date Fund Fees

One of the downsides to a target-date fund is its fees. Fees have decreased in recent years, but investors still need to check that their returns are not being overtaken by outrageous charges. Fees are required to be listed so investors can easily compare various funds, so don’t be afraid to read the fine print. The difference between a fund with fees between 0.49% to 0.76% and one with 0.16% and 0.18% could be $38,000 for someone who invested $5,000 a year for 30 years.

How to Manage Your Target-Date Fund

Too many people choose a target-date fund based on inappropriate considerations. Instead of choosing it based on the date you hope to retire by, consider your tolerance for risk. Some people may be more tolerant and need to invest more aggressively, while others are more conservative. Don’t assume that you have to stick with the date that works for your age. Even though the fund rebalances on its own, investors still need to check how it’s doing. Not all target-date funds are created equal, and each company’s target-date fund is allocated differently and provides different returns. Between Fidelity, Vanguard and T.Rowe Price’s 2020 target date funds, the returns range from 5.5%, 6.58% and 7.15% respectively. You have to examine each fund individually, not as a package deal. Target date funds are perfect for people who make irrational decisions – the funds are designed to allocate based on past returns and current strategy. Investing is a patient man’s game, and TDFs can encourage investors to adopt the strategy of the tortoise instead of the hare. Because TDFs can be used as a “set it and forget it” investment option, they’re ideal for those who get nervous about every slight swing in the market. Target date funds are perfect for people who want to be investing, but don’t want to have to worry about what they’re investing in. You can choose a target-date fund for your 401k or IRA – they’re perfect for either. Related article: How Much Do I Need to Invest?

Basic Investing Terms GenY Should Know: Part 2

Basic Investing Terms GenY Should Know: Part 2

If you were here last week, you already know that I’m aware of just how confusing the financial world can be. The fancy lingo, the 50-page reports and the constant chatter about “what the market is doing” can make you feel overwhelmed, out of the loop, or just plain put you to sleep.

That’s why I decided to take two weeks to dig into some investing basics and make sure that you feel comfortable with the terms and issues you may be confronted with in your financial life. And of course, my aim is to do this in a way that intrigues rather than bores.

If you missed last week’s post on Investing Terms GenY Should Know: Part 1, feel free to review it before diving in here. This week, we’ll jump into retirement account types to ensure you understand the ways in which you’re stocking away money for your future self.

Note: For the accounts below, you have to have earned income in order to contribute. Your IRA and Roth IRAs will be self managed at a custodian of your choosing while your 401(k) is an employer sponsored retirement plan.

Traditional Individual Retirement Account (IRA):

An IRA allows you to contribute pretax income (up to a certain threshold) to an investment account, which can grow tax-deferred, meaning you pay no taxes on principal (contributions) and earnings until funds are withdrawn from the account. For 2014, tax-deductible contributions may be made up to $5,500 to an IRA account. Penalty free withdrawals from your IRA can begin at age 59 1/2 and become mandatory at age 70 1/2. Translation: You’re saving money on your taxes at today’s rates, but you’ll be paying a future (possibly higher) rate upon withdrawal.

Note: For 2014, your Traditional IRA contribution is only deductible if you aren’t covered by a 401(k) at work and your income is below $60,000 if you’re single or $96,000 if you are married.

Roth Individual Retirement Account (Roth IRA):

A Roth IRA is similar to the above Traditional IRA except that contributions are made with after-tax income and therefore are not tax deductible. For 2014, non-tax deductible contributions may be made up to $5,500. There is no mandatory age for withdrawal and there are no taxes due on principal or earnings upon withdrawal from the Roth IRA. Translation: You’re paying taxes upfront at today’s rates, instead of paying the (possibly higher) rates in place when you begin withdrawals.

Note: For 2014, you can contribute to a Roth IRA as long as your income is less than $114,000 if you are single or $181,000 if you are married.

401(k):

A retirement account sometimes offered through an employer. The 401(k) can come with a Traditional or a Roth option depending on your employer offerings. For 2014, tax-deductible (for a Traditional) or after-tax (for a Roth) contributions can be made up to $17,500. Contributions are deducted automatically from your paycheck and for the Traditional option, funds will grow tax-deferred until withdrawal. For the Roth option, there will be no taxes on principal or earnings at withdrawal .

403(b):

A 403(b) is similar to a 401(k) except this account will apply to employees public education organizations and some nonprofits.

Employer Match:

An employer contribution to a company sponsored retirement plan, in which your employer contributes an amount to your plan equal to a specified percentage of your personal contribution. Your employer is essentially “matching” a portion of your contribution. If your employer provides a company match, you’ll typically see language similar to this in your benefits handbook: We will match 50% of your personal contribution to your 401(k) up to 6% of your salary.

Note: It is important to always take advantage of this benefit. Otherwise it is “free money” that you are leaving on the table. Taking advantage will require you to contribute a certain amount of your base pay up to a pre-set limit and the company will match your contribution with funds of their own.

When it comes to putting away money for retirement, just get started! If you have an employer match, take full advantage of the free money offered first and then take some time to review your taxes to make the decision on if the rest of your retirement savings should be put towards a Roth IRA  or 401(k). If you have a low income now and don’t need the tax savings, go ahead and max out your Roth IRA if possible. If you’re in a high income tax bracket and could use the tax savings, consider maxing out your 401(k) to ease your tax strain.

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