Target-date funds: A hands-off investing approach to help you build wealth for retirement

You may not realize it, but your money could be already growing in what's called a target-date fund. Many employer-sponsored retirement plans, such as a 401(k), automatically default to this type of mutual fund as an employee's main investment vehicle for their future.

In short, target-date funds build your investment portfolio around the year you plan to retire. It's a pretty simple approach, and Select covers the nuts and bolts below.

If you plan to retire in, say, 2060, you would pick out a fund closest to 2060. The fund would then choose a combination of stocks and bonds that allow you to take on the largest amount of risk early on. For example, this may look like a portfolio of 90% stocks, or equities, and 10% bonds, or fixed income. Generally, stocks offer potentially greater reward but more risk than bonds, so the idea is to take advantage of that high risk and possible high reward while you're still a ways away from retiring.

As you approach your target retirement date, in this case the year 2060, you'll see the fund shift its investments, and the fund's portfolio will get more conservative as your non-working years draw nearer. For example, this may look like shifting to a portfolio of 50% stocks and 50% bonds — a decrease in stock holdings and an increase in bond holdings — since bonds are considered lower risk assets.

Target-date funds stand out as a simple approach to saving for retirement. Their hands-off concept allows just about anyone to invest without needing to know much beyond the year they want to retire. These funds will rebalance periodically and automatically change your holdings to reflect your risk tolerance over time. All an investor really needs to do is make consistent contributions. This setup also takes away any emotion-based investing, such as trying to time the market, where investors allow their emotions to drive — and at times hinder — their decisions.

Compared to actively managed funds, target-date funds also have lower management costs, better known as expense ratios. The fees of target-date funds can be higher, however, when compared to index-fund investing (another form of passive investing) in funds that follow the S&P 500, for instance.

On the flip side, target-date funds come with some cons as well, one being that they are modeled assuming a one-size-fits-all approach. For example, the funds default to the idea that bonds will always be less risky than stocks, but this isn't true in all economic climates (just look at 2022 as an example). Investors may want a more diverse asset allocation than what target-date funds offer, too.

Though the simplicity of target-date funds can be seen as a positive for many investors, it can actually be a disadvantage to other investors who need to take more into account than just their expected retirement year, such as assets they may have like real estate or cash savings set aside.

Lastly, target-date fund fee structures can be quite complicated to understand. Target-date funds have both a management fee and a fund-of-funds management fee, meaning that your target-date fund portfolio has multiple mutual funds within it, each with its own expense ratio. Take a careful look at what the fund company charges, as they differ from company to company.

The good news is you don't have to have access to a 401(k) plan in order to take advantage of a target-date fund. You can still save for retirement through a target-date fund by putting your money into a tax-advantaged traditional IRA or Roth IRA.

You can also invest in target-date funds through big-name brokers such as Vanguard, T. Rowe Price or Fidelity — each of these platforms offer their own target-date funds that you can purchase. With brokerage accounts, however, keep in mind that you'll likely have greater tax implications when selling mutual funds than you would with a tax-advantaged retirement account.

As another hands-off investing alternative to target-date funds, robo-advisors are an option to consider. While they aren't necessarily as directly modeled to invest for retirement as target-date funds are, they certainly can be used to passively invest for the future. Robo-advisors will customize a portfolio for you based on your risk tolerance, goals and timeline, and they will automatically rebalance your portfolio over time. Two of the pioneers in this space are Betterment and Wealthfront, both of which made Select's list of the best robo-advisors.

Catch up on Select's in-depth coverage of personal finance, tech and tools, wellness and more, and follow us on Facebook, Instagram and Twitter to stay up to date.