The choice of investments in workplace 401(k) plans is often overlooked by employees, with many not actively selecting their funds. According to the Philadelphia Inquirer, only 31 percent of savers in Vanguard retirement plans choose their own investments. This lack of engagement may stem from a lack of awareness or the daunting nature of the task, leading to employers selecting default investments, which are typically target date funds. By the end of 2025, 96 percent of Vanguard’s retirement plans offered these funds, which automatically adjust their asset allocation as the retirement date approaches.
Understanding Target Date Funds and Their Limitations
Target date funds are designed to simplify retirement investing by gradually shifting from higher-risk assets, like stocks, to lower-risk ones, such as bonds, as retirement nears. While they can be a convenient option for those preferring a hands-off approach, financial planner Matt Hylland warns that these funds can carry high fees that may reduce overall returns. For example, Vanguard’s average expense ratio for target date funds is 0.41 percent, but some funds charge between 0.50 percent and 1 percent annually.
Alternatives to Target Date Funds
Investors may consider alternatives such as S&P 500 index funds, which typically have lower fees and allow for broader market exposure. Additionally, some 401(k) plans offer both actively managed and passively managed target date funds. Actively managed funds involve a portfolio manager making investment decisions, while passively managed funds track market indexes, often resulting in lower costs.
What Employees Should Know About Their 401(k) Plans
Employees should be aware of how their 401(k) funds are invested and the fees associated with them. Hylland emphasizes the importance of understanding one’s asset allocation, especially if a more aggressive strategy is desired. Target date funds may reduce stock exposure to as low as 30 percent as individuals age, which might not be suitable for everyone, particularly those looking to keep pace with inflation.
What Employees Can Do Next
Employees are encouraged to review their 401(k) plans and consider whether their investment choices align with their retirement goals. If target date funds are part of their plan, they should assess the associated fees and explore lower-cost options that may better suit their investment strategy.
What 401(k) Plans Are and How They Work
A 401(k) plan is a retirement savings account offered by employers that allows employees to save a portion of their paycheck before taxes are taken out. Contributions can be made on a pretax basis, and investment gains are tax-deferred until withdrawal. Some plans also offer a Roth option, where contributions are made after taxes, allowing for tax-free withdrawals in retirement.
