Image source: Getty Images.
Continue Reading Below
There are literally thousands of retirement-focused funds to invest in, offered by companies such as Vanguard, T. Rowe Price, and American Funds, just to name a few. When choosing retirement funds for your IRA, 401(k), or 403(b), it's important to consider factors such as the fund's expenses and investment objectives.
What is a retirement fund?
Before we get started, note that for our purposes, "retirement fund" refers to a mutual fund or exchange-traded fund in which you can invest your retirement savings -- not an account thatholdsyour retirement savings, such as an IRA or 401(k).
The most common type of retirement fund is known as atarget-date fund, which gradually adjusts its asset allocation over time, and is specifically designed for retirement savings. These funds generally have a year in their title, such as the Vanguard Target Retirement 2030 Fund (NASDAQMUTFUND: VTHRX), which is intended for people who plan to retire between 2028 and 2032.
As of this writing, this fund has about three-fourths of its assets in stocks and the remainder in bonds. The idea is that because its investors are (presumably) about 15 years away from retirement, there is still plenty of time for them to take advantage of the growth potential of stocks and to ride out any short-term volatility. As the target date approaches, the fund will gradually reduce its stock exposure and increase its bond holdings in an effort to preserve capital and generate income. Eventually, most of the assets (but not all) will be in bonds. According to Vanguard, the allocation will continue to shift until seven years past the target date, at which point the fund will have an allocation of approximately 30% stocks and 70% bonds.
While target-date funds are typically what the phrase "retirement fund" refers to, that doesn't mean they're the only appropriate investments for your retirement portfolio. There are thousands of funds that could play a part in your retirement planning, designed for a wide variety of investment objectives and risk tolerances. However, before you can narrow down your search, you'll need to know what to look for.
What to look for in a retirement fund
Regardless of the type of retirement fund you're looking for, there are a few things to consider when weighing your options:
Expense ratio: A fund's expense ratio refers to the costs of owning that fund, expressed as a percentage of that fund's assets. For example, if a fund has a 1% expense ratio, that means you'll pay $10 in annual fees for every $1,000 you invest in the fund. Expense ratios vary significantly based on the type of fund, and while there is no standard for what makes a "good" expense ratio, here are the guidelines I recommend:
- For passively managed funds, such as those that track a certain stock index, look for expense ratios of 0.25% or less.
- For actively managed funds, in which managers actually select investments to buy and sell, look for expense ratios below 1%.
We'll discuss examples of both fund types in the next section.
Investment objectives: If you're relatively young, then your priority should be growing your money, so you need funds that can help you do that with a reasonable level of risk. As you approach retirement, you'll want to focus more on preserving your nest egg and generating income, so you should look for funds that can do that. Of course, within both categories, there is a wide variety of risk, so you can tailor your fund selection to your own risk tolerance.
Past performance: While a fund's past performance doesn't guarantee its future results, it's still an important piece of information to look at. For a passively managed fund, you'll want to make sure the fund does a good job of matching the performance of the index it tracks. Meanwhile, actively managed funds that consistently deliver strong results tend to continue to do so.
Ratings: You'll see a few different ratings assigned to mutual funds, such as those from Morningstar and S&P, which rank funds based on several factors. Much like past performance, these ratings should be taken with a grain of salt, though they can be help you find reasonably priced funds with attractive risk-reward profiles.
Examples of two popular retirement funds
These funds aren't "retirement funds" in the sense that they cater specifically for retirees. Rather, they're great investment funds for anyone who wants to put some money into the stock market but doesn't want to buy individual stocks.
One popular approach for retirement planners is to simply buy an S&P 500 index fund. In fact, Warren Buffett has said that a low-cost S&P 500 index fund is the best investment for most people. A good example is Vanguard's version, which is available in the form of a mutual fund, the Vanguard 500 Index Fund (NASDAQMUTFUND: VFINX) or as an ETF, the Vanguard S&P 500 ETF (NYSEMKT: VOO). Both options have low expense ratios (0.16% and 0.05%, respectively) and do a good job of replicating the index's performance.
As an actively managed example, the Dodge & Cox Stock Fund (NASDAQMUTFUND: DODGX) is one of my personal favorites, and it's one of the most popular funds available in 401(k) plans, with $54 billion in total assets. The fund has been around since 1965 and has averaged 10.83% returns since that time, after accounting for its 0.52% expense ratio. Essentially, the fund's objective is to invest in undervalued stocks that have the potential to deliver market-beating returns over time. Current top holdings include Wells Fargo, Capital One, Bank of America, and Hewlett-Packard.
Find the best funds for you
Of course, these are just two examples that illustrate what to look for in the best retirement funds. You can apply the principles discussed here to your own search. Keep in mind that there is no single correct answer. As long as the funds you choose have reasonable fees and meet your needs, they may be the perfect retirement funds for you.
The $15,834 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $15,834 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.Simply click here to discover how to learn more about these strategies.
Matthew Frankel owns shares of Bank of America. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.