Choosing how to invest your workplace retirement plan savings can be a daunting task. All this jargon like “risk,” “equities,” “asset classes,” and “diversification” can be overwhelming. So, what happens if you don’t feel comfortable choosing investments? If you don’t select any investments for your retirement savings, your employer will choose for you. Each retirement plan has a “default” investment option for participants who do not choose investments. You also can choose the plan’s default fund or move your existing money into the default fund, which may make sense for some investors.
Popular default funds, such as risk-based funds and target date funds, may help remove some of the guesswork typically associated with retirement plan investing. (Related: What is a 401(k)?)
These funds will automatically invest your savings across many different investment types in a mix that is appropriate for your risk tolerance or age group. For this reason, they are considered total portfolio solutions so that your retirement plan account should only invest in one of these funds and nothing else.
Common types of default funds
Employers typically choose one of the following types of investments as a default fund in their plan.
Risk-based funds are a group of funds that are managed to maintain a certain level of investment risk. Risk-based funds are often categorized as Conservative, Moderate, or Aggressive. A conservative fund would include a greater proportion of low risk (more stable) investments to prevent the potential for large losses in the fund, though the potential for high returns is reduced. In contrast, an Aggressive fund would include a greater proportion of high risk (more volatile) investments that carry a greater chance of loss but also a greater potential for higher returns. Because risk-based funds are designed to align with a specific level of risk tolerance, they are rebalanced regularly to maintain a static investment mix.
Retirement plans that offer risk-based portfolios usually provide an online questionnaire or other tools to help you determine which fund is most aligned with your risk tolerance and retirement savings objectives. Based on your responses to the questions, you will be directed to a portfolio or a fund with a specific investment mix. (Related: Why identifying your risk profile is essential to investing
Target date funds are a group that is managed to meet the accepted investment objectives of an investor based on their age or number of years until retirement. For instance, if you are 35 in 2022, you will be 67 (i.e., full Social Security retirement age) in 2054. So, you might want to choose a Target Date 2055 Fund, if offered by your plan. Target date funds are created in 5 or 10-year increments, so you would choose the fund with the date closest to when you think you will retire.
The underlying investments in a target date fund are managed based on the time horizon until the target retirement year. The longer the time horizon, the more aggressive the target date fund can afford to be because there is more time to ride out any market downturn. On the other end of the spectrum, investors who are closer to retirement have less time to recover from a market decline, so target date funds with a coming retirement year typically maintain a more conservative investment mix.
Like risk-based funds, target date funds are a well-diversified investment. Target date funds, however, do not maintain a static investment mix. One of their advantages is that their investment mix automatically adjusts over time. As you get closer to your retirement year and your time horizon shortens, the investment mix becomes more conservative.
Check your investments
Whether your employer automatically selected the plan’s default fund or you chose the default investment, you can rest assured that it is a well-diversified investment portfolio that can be a prudent investment solution.
However, your retirement savings is a valuable financial asset, so it’s wise to revisit your investment selections periodically to ensure you’re still in the best option for you. Your financial professional can help you choose the investments best suited for you.
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