Target-date funds: What they are and when they’re a good investment

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Target-date funds are an increasingly popular way for Americans to invest for the future. In fact, more than $2.8 trillion were invested in them at the end of 2022, according to Morningstar. And they’re especially popular in 401(k) plans, helping workers manage their retirement finances.

Here’s what a target-date fund is, how it works and its advantages and disadvantages.

What is a target-date fund?

A target-date fund is a mutual fund (or exchange-traded fund) that gradually rebalances and reallocates assets as you get closer to retirement, typically shifting the majority of assets from riskier investments such as stocks to more conservative investments such as bonds and cash. The fund is designed as a one-stop investment shop with a diversified set of asset classes.

With a target-date fund, investors pick the year they think they’ll need to access the funds, say, 2040, and then the fund management company manages everything from there.

How target-date funds work

Building a well-diversified portfolio can be overwhelming for individuals who are not investing experts. Target-date funds are popular because they simplify the process for participants, says Jean Young, senior research associate at Vanguard Investment Strategy Group.

Target-date funds aim to alleviate the ongoing task of a successful investment strategy: rebalancing and optimizing asset allocations. Target-date funds offer investors the convenience of automatically allocating assets in the fund from day one. But these funds can also improve returns for investors. Some studies have shown that up to 90 percent of an investor’s return depends on how money is divided between various asset classes, from equities such as domestic and global stocks, to fixed-income investments such as bonds and cash.

Target-date funds, often a type of mutual fund, are a “set it and forget it” investment option. After participants set their contribution from their paycheck and select the funds, the asset mix in the funds automatically adjusts, slowly becoming more conservative as participants get older and closer to retirement.

Consider, for example, a 2060 target date fund, which is geared toward investors who plan to retire around 2060. Early in the fund’s timeline, assets are geared toward higher-risk, higher-reward assets such as stocks. As the fund gets closer to its target year, risk is dialed back with a more conservative portfolio of fixed-income investments.

This aggressive-to-conservative switch doesn’t happen overnight. Instead, a target-date fund operates on a glide path. Think about an airplane descending on final approach to land. A target-date fund’s glide path employs a similar rationale — easing the investor to a safe financial destination at retirement.

“That’s why target-date-funds are growing at Vanguard and all the major providers,” Young says. “It’s just simply easier for people.”

At year-end 2022, 66 percent of all Vanguard plan participants were solely invested in an automatic investment program — compared with 7 percent at the end of 2004. More than half of participants (59 percent) were solely invested in a single target-date fund, according to Vanguard’s “How America Saves 2023” report.

Advantages of target-date funds

The growing popularity of target-date funds is due to the significant advantages they offer investors.

You can put your investing activities on autopilot

A target-date fund eliminates the need to constantly monitor and adjust your portfolio and reduces the stress associated with financial planning by the time you get to retirement. The fund has a defined trajectory when allocating assets in the portfolio. As you approach your target date, the fund will gradually make your portfolio more conservative, helping to ensure that your money is there when you need it.

You can make adjustments if necessary

If your time horizon changes, you can switch to a more applicable fund. If you determine that you are going to work for an additional five years, you can move your money into the 2065 target-date fund or even later, if needed.

Increasingly lower fund fees

As target-date funds have become more popular and had to compete against cheaper funds, their fees have come down significantly. Their asset-weighted average expense ratio was 0.32 percent at the end of 2022, according to Morningstar. That means an investor would pay $32 annually for every $10,000 invested. That’s down from 0.66 percent in 2017, or $66 annually.

So when it comes to expenses, target-date funds compare well to the average mutual fund, though the average expense ratio is still higher than the average ETF.

Disadvantages of target-date funds

Of course, target-date funds have some disadvantages compared to other funds.

Fund expenses can add up

Saving for retirement requires spending some money. Target-date funds all have expense ratios, and it’s important to compare these before selecting one for your money. You may notice that some target date funds carry higher fees than the index funds within them. Keep these expenses as low as possible to maximize your potential earnings.

While the fees have been coming down, you may be able to find cheaper funds and manage the portfolio yourself.

No earnings are guaranteed

Target-date funds are investments, and all investments have the potential to lose value. It’s a simple reality of saving for retirement: You need to accept some degree of risk when investing for retirement.

For example, with interest rates rising meaningfully in 2022, some funds thought to be positioned conservatively saw large declines as the rise in rates hurt both bond and stock prices. The Vanguard Target Retirement 2025 Fund (VTTVX) fell more than 15 percent in 2022, despite being close to its target date.

Funds may get too conservative too quickly

As you approach your target date, target-date funds move more of your money from stocks to bonds. However, this approach lowers your overall potential return, creating a drag on performance in exchange for relative safety. If the fund moves too much money into bonds too quickly, it could severely hit your potential retirement income. And with many seniors living more than two decades after they retire, retirees may need the extra growth provided by stocks.

One solution: buy a target-date fund that’s five or 10 years later than you actually want to retire. This later-dated fund will have a higher allocation to stocks, potentially giving you more growth.

Are target-date funds a good investment?

Target-date funds help people wade through the waters of investing, says Jennifer Shulman, owner of Simply Balanced Solutions LLC, a Florida-based professional daily money management firm.

But she stresses that they don’t solve all problems for all people all of the time. Long-term, people will want to see a certified financial planner for guidance on the right portfolio mix and knowledge about the limitations of passively investing through target-date funds, she says.

While a target-date fund can be a simple way to spread your money across investments that match your age and retirement needs, not all funds of the same target date are created equal. For example, one 2060 fund from a provider may be more aggressive with more money in stocks than another 2060 fund from a different provider. To determine if the target-date fund is a good investment for your needs, read the fund’s prospectus and review the current portfolio breakdown and fee structure.

Keep in mind that the target date represents the beginning of another chapter in your life. The fund sets you up for retirement, but you will also need a plan for putting your money to work after you leave the workforce. After the fund reaches its target date, it shifts to a retirement fund. At that point, consider keeping some of the money in the fund while allocating some cash toward other investments to earn regular income from your savings.

As part of this switch from work to retirement, it can be worthwhile to meet with a financial advisor. A good advisor can help you make the right choices for your situation, setting up a financial plan that takes into account your whole financial plan, including Social Security. (Here’s how to find a financial advisor who will work in your best interest.)

“In the accumulation phase, the target-date fund does a pretty decent job when the only thing we know about you is the year you might retire,” Young says. “Ultimately, we should all have a custom solution that takes into account not just what you have in your current plan with your current employer, but your entire asset picture.”

Can I hold onto a target-date fund after the target date?

Certainly, you have the option to hold onto your target-date fund even after reaching the specified retirement date. These funds continue to operate and adjust their asset mix, often becoming progressively more conservative. 

For instance, ‘through’ target-date funds continue altering their asset mix for years after the target date until they stabilize at a more conservative allocation. Meanwhile, ‘to’ target-date funds reach their most conservative asset mix right on the target date, with no significant adjustments thereafter. 

It’s important to note that some target-date funds might merge into other funds designed to provide income during retirement. Should such a merger occur, it’s crucial to review the new fund’s prospectus to ensure it suits your investment objectives and risk tolerance.

Bottom line

Target-date funds offer a good, but not perfect, solution for investors who don’t want to manage their own retirement portfolio. Despite their drawbacks, many investors will find them to be a valuable addition to their portfolio, and they’re becoming increasingly less expensive, meaning investors can enjoy their benefits for only a relatively small premium over traditional funds.

Note: Adrian Garcia contributed to a previous version of this article.