Investing for retirement when you're just starting out

NEW YORK (CNNMoney) -- My granddaughter has asked me how to invest the money she'll contribute to her employer's retirement savings plan at her first job. I suggested she either go with a 2050 target-retirement fund or divide her money as follows: 40% in an S&P 500 index fund, 40% in a small-cap index fund and 20% in an international stock index fund. Do you think she should go with the first option, the second or do something else? -- Don G.

Kudos for recommending that your granddaughter take a diversified investment approach via a target-date fund or by spreading her money among more than one asset class herself.

I prefer your first recommendation -- the target-date fund -- over the second. The target-date fund is an excellent choice for almost anyone just starting out in his or her career.

The appealing feature of target-date funds is their simplicity. You choose a fund with a date that roughly corresponds to the year you'll retire -- 2050, 2060, whatever -- and you get everything you need rolled into one fund -- domestic stocks, international shares, a diversified portfolio of bonds. They are nice for newbie investors or anyone who lacks the time, skill or inclination to build and monitor a retirement portfolio on his or her own.

And while not all target-date funds provide those key ingredients in the same proportion, generally the portfolios have reasonable allocations. Most 2050 funds, for example, would have about 90% of their asset in stocks (with roughly 30% or so of that stake in foreign shares) and the rest in a diversified group of bonds. Over time, that mix automatically becomes more conservative, shifting toward bonds.

Target-date funds aren't perfect. Some may have bloated fees. And some can be much more aggressive than others, although that's more of a risk closer to or during retirement. In any case, don't invest and then completely forget about these target date funds. Check their performance from time to time and make sure you're comfortable with them, especially during market downturns.

Your second option -- having your granddaughter create her own portfolio --is also acceptable. She would just have to devote more time and effort to her investing by choosing funds, deciding how to divvy up her assets among different asset classes and rebalancing occasionally.

I would, however, recommend a few changes to the allocations you suggest. Your mix has her 100% invested in stocks. To be on the safe side, I'd recommend having a small slug of bonds, at least 10% or so.

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Instead of allocating half of her domestic stock portfolio to volatile small-cap stocks, I'd recommend sticking closer to the market weighting for small- and mid-cap stocks. Combined, these stocks make up about 30% or so of the overall U.S. stock market.

The easiest way to do that would be to create a portfolio much like that of the typical 2050 target-date fund. Of course, if she's going to do that, then why not just stick with the 2050 fund itself? It would be easier, cleaner and less prone to mistakes (like failing to rebalance periodically).

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One final note: Once she's settled on an investment strategy, tell her to contribute as much as she can afford to her plan, and certainly at least enough to take full advantage of any employer match.

Even though we tend to pay much more attention to the investing side of the retirement planning, diligent saving is the real engine for creating retirement wealth.

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