KEEP IT SIMPLE WITH AN INDEX OR TARGET-DATE FUND Inside your retirement account, you’ll have anywhere between 10-30 investment choices to pick from. They will probably all be mutual funds, index funds, or target-date funds. Mutual funds pool money from investors to buy a lot of different stocks from many different companies. By owning a share of a mutual fund, you are “spreading” your money out among all the companies that fund owns. This “spreading-out” is called diversification and it’s a key concept for long-term investing. The basic idea is that the more diversified your portfolio, the lower your overall risk. Mutual funds hire managers to buy and sell company stock in the fund’s portfolio according to the fund’s goal – whether it be growth, income, or both. These managers cost money, and so does advertising and distribution of the fund’s shares. All these costs are wrapped into a percentage called the expense ratio. The higher the expense ratio, the higher the return the fund needs to keep up with, or beat, standard benchmarks like the S&P 500 (an index of the 500 largest publicly-traded companies in the U.S.). You can choose a few mutual funds in your 401(k) to make sure you’re spread out across different sizes and types of companies, or you can pick an index fund to simply mirror an entire index. For example, an S&P 500 index fund mimics the index for which it’s named after – containing all 500 of the companies listed! Managers aren’t needed to buy or sell stocks into and out of the fund, since it just follows the returns and losses of the index day-to-day. For this reason, index funds are generally cheaper (with a lower expense ratio) than their more actively-managed mutual fund cousins. Because of their convenience, cost and simplicity, they’ve been growing in popularity as alternatives or supplements to actively managed mutual funds. If you really want to keep things simple to start, a target-date fund might be the ticket. A target-date fund doesn’t track one index, but rather contains a diversified set of mutual funds that risk-adjust automatically over time as you get closer to retirement. They are named after the year you think you will retire, and become more conservative the closer your retirement date becomes. For example, a 2050 target-date fund would consist mostly of stocks today, but gradually shift to a higher percentage of bonds over the next three decades to the 2050 retirement date, since bonds are generally less risky than stocks. In this way, a target-date fund is a kind of one-stop shop for investors who have a “set it and forget it” mentality when it comes to investing, but you should check their expense ratios before going with one of these over a widely diversified index fund or two. AVOID LIFESTYLE CREEP Inflation is the rising cost of goods and services in our country, and it slowly takes a bite out of our spending power as we age. At the current rate of inflation, prices will double about every 20 years, which means a one-million-dollar retirement fund today would need to be two million dollars in 20 years to buy the same amount of goods and services. One way to make sure you’re saving as much as you can is to increase your contributions when you get raises you don’t necessarily “need” to sustain your quality of life, and to invest windfalls and bonuses as they come. These bumps in your portfolio will compound to big gains
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