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3 Common Mistakes Savers Make When They Invest in Target-Date Funds

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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Target-date funds (TDFs) are one of the most popular investment options offered by employers because they provide employees an all-in-one portfolio within their retirement plans. To show how popular they are, more than 70% of all 401(k)s provide TDFs, and approximately 50% of participants own them. However, most employees don’t even know what target-date funds are or how they work.

So why the fuss about target-date funds? Although popular, many participants are misusing them and hurting themselves in the long run.

What a Target-Date Fund does:

A TDF is simply an investment fund that owns a bunch of index-style mutual funds. Because TDFs include funds with broad exposure to different types of assets, they allow novice investors to access countless stocks and bonds. For example, the Vanguard 500 Index Fund tracks the S&P 500, which gives investors access to 500 different stocks. A TDF may contain several funds similar to the Vanguard one.

According to a recent study by Aon Hewitt, retirement savers who choose to invest in a single TDF and no other funds had higher investment returns by over 2%. In addition, those participating in TDFs outperformed people who manually managed their retirement investments by a whopping 3%.

Here are some reasons they have been misused, how to overcome them, and why you only need one in your portfolio.

Choosing the wrong year

The name “target-date fund” means exactly what it sounds like. You choose a fund based on the year or “target date” that you plan to retire. TDFs are offered in five-year increments — 2035, 2040, 2045, 2050, and so on. Your goal is to pick a TDF associated with a date that is closest to when you expect to retire.

For example, if you’re 25 years old today and plan to retire at age 65, you would opt for a 2055 TDF option.

Why does the year matter so much? Because the closer you get to retirement, the more conservative your investments should become. This is important, because you have less and less time to bounce back from setbacks as you get closer to retirement. The way TDFs work, they tend to be more heavily invested in risky assets like stocks in your early working years.

“As the investor ages and moves closer to their intended retirement date, a target-date fund will reduce the overall investment risk,” explains John Croke, a certified financial adviser with Vanguard. This process is known as the glide path.

Choosing more than one TDF

Since TDFs are pretty straightforward, many people mistakenly think that they need to split their retirement savings among more than one TDF in order to be truly “diversified.” But the whole point of a TDF is that you only need to invest in one — it is automatically diversified among many assets for you.

“TDFs are designed as ‘all-in-one’ solutions that provide automatic diversification across multiple asset classes,” Croke says. “Owning more than one TDF is not advised or necessary.”

You shouldn’t treat your TDF as if you were a day trader trading stocks either. It’s better to invest in your TDF and keep your funds there rather than to jump in and out trying to time the market.

Paying too much in fees

Compared to traditional mutual funds, TDFs are especially appealing because they charge such low fees. In the world of investing, fees come in many different forms, but the important fee to watch out for is called the “expense ratio.” This is the amount your fund manager charges you for the ability to own that fund. Expense ratios can be as low as a fraction of a percentage or as high as several percentage points. It may not sound like much of a difference, but even a difference of one or two points can mean losing tens of thousands if not hundreds of thousands of dollars over the decades until you retire.

Also, participating in more than one fund just subjects you to more fees that are unnecessary. Why pay more when you don’t have to?

The final word

All in all, TDFs provide an easy, diversified, and low-cost means to invest for retirement. All you need to do is choose one that matches the year you plan to retire, make tax-deferred payments from your paycheck into the fund, and allow your account to grow with history proving that time is on your side when it comes to the markets.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Eric Patrick
Eric Patrick |

Eric Patrick is a writer at MagnifyMoney. You can email Eric here

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Investing

5 Easy Steps to Buy Your First Stock

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

5 Easy Steps to Buy Your First Stock

The stock market can seem complicated, but most people agree that it’s a necessary component to achieving financial wellness. There are a few steps needed when buying your first stock. Let’s go through the basics for your first purchase.

5 steps to buying your first stock

First thing’s first: Save money to invest.

We’ve all heard the phrase, “It takes money to make money.” Although this is true, it’s best to have a proper plan in place to build up a personal fund specifically for buying your first stock.

Before you begin setting aside funds to invest, make sure you’re actively paying down debt and setting aside money for an emergency fund. The S&P 500 has returned 11% annually on average since 1928 (not adjusting for inflation). If you owe money on a credit card or loan with an interest rate over 11%, it would actually be more beneficial to pay that off first and then start transferring money into your investment fund.

After you’ve reached your emergency fund goal, start setting aside money to invest. A great way to do this is by saving a set amount of your income in scheduled increments. Try starting with 5% of your paycheck and increase contributions as you become more comfortable. Consider setting up a direct deposit to a separate high-interest savings account so you won’t be tempted to spend this money.

Now you’re probably wondering — how much should I save before I start investing?

Some newer online investing platforms allow novice investors to buy fractional shares rather than whole shares. Fractional shares are simply smaller portions of a total share. That means you can start investing with much less than you would need at a traditional brokerage firm. Check out some of these companies if you want to start investing with as little as $5.

Check with your broker to see what their commissions are and how much it takes to make an initial investment. $100 is typically a good price point to begin when purchasing your first stock or exchange-traded fund (ETF) as many cost less than that. In contrast, a typical index or mutual fund may have an initial buy-in of more than $1,000 to get started.

Choose and fund a brokerage account.

The stock market is a highly regulated industry with stocks trading on major exchanges like the New York Stock Exchange and the Nasdaq. When you plan to buy your first stock, you’ll need to use a brokerage firm in order to complete your purchase. There are many online discount brokers that allow first-time investors to buy stocks without a lot of upfront costs.

Choosing a brokerage firm can come down to many variables, but the primary one new investors look for is cost. Online discount brokers have made it easier for new investors to participate. Typical commissions — that’s how much they charge you every time you make a buy or sell stocks — run between $5 and $10 at firms such as TD Ameritrade and TradeKing.

Newer firms such as Acorns and Stash are allowing new investors to start with as little as $5 right from their phones, allowing them to buy fractional shares.

Research companies to buy.

There are over 6,200 publicly traded companies listed on the New York Stock Exchange and Nasdaq, which can seem extremely intimidating to first-time investors. Basic research methods can narrow down your list tremendously, helping you find your first stock faster. This can be done through your broker’s online portal or with free sites like Yahoo Finance and Google Finance.

An easy way to get started is to think about items you use on a daily basis or companies you frequently patronize. Simply looking at who makes your cellphone, the type of car you drive, or whom you bank with can present potential companies when buying your first stock.

Once you have a list, use your broker to find and read over quarterly and annual financial reports of those companies. Just as you would personally want consistent positive cash flow (more income than expenses), you want to make sure a company you plan to own does too.

Buying individual stocks can be time consuming and stressful, particularly for new investors. Consider low-cost exchange-traded funds (ETFs), index funds, or other mutual funds to alleviate some of the search process and provide great diversification at the same time. In addition to diversification, you also want a fund that has a low expense ratio, fund manager stability, and an overall consistent positive performance. Strive for a fund that averages over 3% growth annually to combat inflation.

Fidelity and Vanguard are leading the industry in regards to low-cost index and mutual fund options.

Decide how many shares you want to buy.

Once you’ve narrowed down your list to one stock you want to buy, you’ll need to decide how many shares of that stock you want to own. One share represents a single unit of ownership within a company. The more shares you buy, the bigger the percentage of the company you own. Don’t think you have to buy a lot initially. Start small, and grow your holdings.

A great method to use is dollar-cost averaging (DCA). This is when you buy a block of shares based on how much money you have, not how many shares you want. This technique is popular because it makes sure investors purchase more stocks when the value of a stock is low and fewer stocks when the value of a stock is high. For example, if you have $200, you can buy 20 shares at $10 each. When you save up another $200, and shares have appreciated to $18 each, you can now only buy 11 shares. Since you spent a total of $398 on 31 shares, your average purchase price is $12.84. That’s how DCA works.

As mentioned earlier, newer firms are allowing new investors to buy partial shares because they are buying based on price, not quantity.

Place your order.

There are two major types of orders when buying your first stock: market order and limit order. A market order allows you to buy shares at current market value, while a limit order allows you to buy shares at a specific target price.

Market orders are typically the method new investors use as limit orders are primarily used for short-term investing.

Welcome to the club!

You’re officially a stockholder. In a perfect world, your stock will always increase in price, but the stock market isn’t perfect. Remind yourself that you’re in it for the long term and that the annual average is on your side.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Eric Patrick
Eric Patrick |

Eric Patrick is a writer at MagnifyMoney. You can email Eric here