Target-date funds are a popular choice among investors saving for retirement. However, will a target-date fund give investors the income they desire? There are pros and cons to choosing a target-date fund.
Key Takeaways
- Target-date funds create a passively indexed portfolio that automatically rebalances based on an investor's time until retirement.
- Target-date funds limit investment choices and decisions.
- These funds usually have a one-size-fits-all strategy.
What Is a Target-Date Fund?
An investor's anticipated year of retirement is the "target date" of a target-date fund. This type of fund works best for those who can estimate their retirement age and year. Many financial institutions offer target-date funds. The fund names are transparent, like Fidelity Freedom 2050 (FFFHX), which targets individuals who plan to retire in 2050.
Each fund commonly invests in a portfolio of assets, aiming for growth while reducing risk. As individuals get closer to retirement age, the asset allocation becomes more conservative to preserve wealth. A target-date fund is like an automatic portfolio manager that makes weighting adjustments for the investor over time.
In 2023, 64% of retirement contributions were invested in target-date funds, up from 59% in 2022, according to Vanguard. Target-date funds have become a default option for many employer-sponsored 401(k) plans. The Pension Protection Act of 2006 helped employers develop retirement plans and set up employee automatic enrollment, making target-date funds an easy option for retirement plans with their low fees and diversified portfolios.
Investors should evaluate the costs of target-date funds among companies and funds. For example, the expense ratio of the Vanguard Target Retirement 2050 Fund (VFIFX) is .08%, while the expense ratio for the Fidelity Freedom 2050 Fund (FFFHX) is .75%.
Advantages and Disadvantages
Pros
Handle rebalancing of assets automatically
Easy enrollment process for employees and employers
Funds provide full diversification
Best for passive investors
Cons
Target-date funds may be too conservative near retirement date and forego returns
Fees vary among funds
Individuals are not actively involved in investment choices
Employees with varying income levels and professions are offered the same plans
Investing Alternatives
According to Vanguard, target-date fund investors are four to five times less likely to engage in trading and active account management than other investors. Financial situations differ by individual and some investors do not have an employer plan that defaults to a target-date fund. These individuals can choose a target-date fund through a financial institution or save for retirement with options such as:
- Mixed Portfolio: Investors can choose to invest a portion of retirement savings into a target-date fund with an employer 401(k), but independently and actively manage other types of investments with the help of a financial institution or advisor.
- Index Funds: These funds are not actively managed, meaning securities are not bought and sold by a portfolio manager as in the case of actively managed mutual funds. Investors can choose a stock index fund and a bond index fund and make weighting adjustments on their own or with the help of a financial advisor.
- Risk Management: At the beginning of a career, investors may choose to invest in a higher percentage of higher-risk stocks. As they get closer to retirement, wealth preservation becomes more important. Investors can reallocate their investment holdings to fixed-rate investments such as bonds. The fixed interest payments from bonds create a steady income and reduce volatility or price fluctuations in the portfolio.
Retirees commonly count on IRAs, 401(k)s), Social Security, and savings to generate retirement income. Investing, including building a diversified portfolio, can help attain long-term financial goals.
Who Benefits Most From a Target-Date Fund?
Target-date funds benefit investors who do not follow investment markets, learn how to invest, and take a hands-on approach to their retirement. They’re even a smart move for people inclined to frequently change their fund allocation inside their 401(k). Target-date funds help to keep people disciplined in their investment choices.
Can Individuals Choose Multiple Funds With Different Target Dates?
Those who choose a target-date fund should make it the only investment in a 401(k). Many 401(k) holders try to use them to complement other funds, but they aren’t designed for that. It is also a mistake to spread out investments between a few target-date funds, a common misstep.
Are Target-Date Funds Regulated?
The U.S. Department of Labor (DOL), the Office of the Comptroller of the Currency (OCC), and the U.S. Securities and Exchange Commission (SEC) are tasked with overseeing the management of target-date funds using disclosure requirements, enforcement, and examinations.
The Bottom Line
Target-date funds are a common investment option for 401(k) accounts. Individuals choose a fund that matches their year of retirement. The fund will rebalance assets automatically until that target date.
FAQs
Target-date funds benefit investors who do not follow investment markets, learn how to invest, and take a hands-on approach to their retirement. They're even a smart move for people inclined to frequently change their fund allocation inside their 401(k).
What is better than a target date fund? ›
Index funds typically offer lower costs, broad market exposure, and simplicity, while target-date funds are a hands-off, all-in-one investment vehicle. Factors to consider when choosing between target-date and index funds include your investment goals, risk tolerance, and time horizon.
What is one disadvantage of a target date fund? ›
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.
Should I choose managed account or target date fund? ›
“A managed account has the flexibility to take into account more participant information than a personalized target-date fund.” Managed accounts also provide an “advice component,” which personalized target-date funds don't provide, Powers added.
Why would someone buy a target-date fund? ›
Target-date funds are popular with 401(k) plan investors, particularly those who don't have the time or the inclination to review their fund's holdings annually and revise their investment strategy appropriately. TDFs allow investors to put the work on autopilot.
Can you get out of a target-date fund? ›
Yes, you can withdraw your money at any time. However, if you retire early (before age 59 1/2), you may be subject to a tax penalty for early withdrawal.
Do target-date funds outperform S&P 500? ›
A target-date fund is generally a "fund of funds," meaning that the investor is paying an extra layer of fees. Those additional fees could make the fund's actual return compare unfavorably to other options for a retirement portfolio, such as an S&P 500 Index Fund. Securities & Exchange Commission.
Should I invest my 401k in a target date fund or index fund? ›
If you're interested in a "set it and forget it" style of investing, target-date funds are more appropriate for you. The fund will automatically rebalance and shed risk as you approach retirement. Target-date funds also have the advantage of typically being more diversified than broad index funds.
How do you make money with target-date funds? ›
While you set and forget, the fund updates your asset allocation through the years. Early in your working life, a target-date fund generally is set for growth by having a much larger slice of your portfolio in stocks rather than fixed-income investments like bonds, which are safer but provide smaller returns.
Why target-date funds may be inappropriate? ›
For one thing, the composition of target-date funds and the reallocations that occur over time suggest the only thing determining an investor's risk profile is how old they are. Many other factors go into that, including their assets and liabilities. The other issue here is diversification.
Factors to consider when selecting target date funds include expense ratios, fund performance, and investment philosophy.
Are target-date funds too expensive? ›
Too expensive
Target-date funds can have higher fees than many stock index funds, given that they automatically rebalance from winners to losers and shift toward a more conservative investment mix over time.
Are target-date funds high risk? ›
Target date funds (TDFs) mix several different types of stocks, bonds and other investments in a single solution to help you prepare for retirement. They take more investment risks when you're young and gradually get more conservative as you near retirement.
Are Vanguard target-date funds good? ›
Our target-date funds (TDFs) have historically provided higher returns with less volatility than their peer averages. That means more retirement confidence for participants and more fiduciary confidence for you. And that's a win for everyone.
What is one advantage of choosing a target date fund as your primary retirement investment? ›
What are the Primary Benefits? With Target Date Funds, you enjoy broad diversification and ongoing professional management. Target date funds are automatically reallocated and rebalanced, implementing the kinds of decisions we all mean to make over our working career, but often don't.
What year should my target-date fund be? ›
Target Date Default Age Chart
| Target Date Fund | Date of Birth From | Date of Birth To |
|---|
| Target Date 2030 | July 1, 1963 | June 30, 1968 |
| Target Date 2025 | July 1, 1958 | June 30, 1963 |
| Target Date 2020 | July 1, 1953 | June 30, 1958 |
| Target Date 2015 | July 1, 1948 | June 30, 1953 |
8 more rowsAutomatic rebalancing: Target date funds are automatically rebalanced periodically to maintain their target asset allocation, so that swings in the markets do not throw a participant's allocation off course.
How efficient are target-date funds? ›
As expected, the long-term results were more favorable for TDFs with more distant target years. For example, over the entire 15-year period, pre-2020 funds yielded 4.9% annually, 2020 funds 5.5%, 2025-2030 funds 5.7%, 2035-2040 funds 5.8%, and 2045-2050 funds 6.0%.
What is one advantage of choosing a target-date fund as your primary retirement investment? ›
What are the Primary Benefits? With Target Date Funds, you enjoy broad diversification and ongoing professional management. Target date funds are automatically reallocated and rebalanced, implementing the kinds of decisions we all mean to make over our working career, but often don't.
