Investing Investing Basics

Target-Date Funds: How to Know if They’re Right for You

Target-date funds aim to simplify the investing choices you need to make by creating an asset that changes as you get closer to your target date. But are they a good idea for you?

By Lance Cothern
and Roger Wohlner

Edited by Becca Borawski Jenkins

Updated Aug. 7, 2024

Target-date funds (TDFs) are mutual funds that hold a mix of asset classes allocated toward a target retirement date. Over time, the allocation of the TDF to stocks decreases as you get closer to the target date.

Target-date funds may work well for certain individuals as long as they understand how these funds work. Even so, you need to examine the specifics of the fund's investments, the fees charged, and what to expect as you get closer to the target date the fund specifies.

TDFs could be an appealing option if you're learning how to invest money and aren't comfortable managing your own retirement investments. Here's what you should know before you decide whether target-date funds are the right investment strategy to grow your retirement savings.

In this article

What is a target-date fund?
How target-date funds work
Pros and cons of target-date funds
How to invest in target-date funds
FAQs about target-date funds
Bottom line

What is a target-date fund?

Target-date funds are a vehicle for investment, usually in the form of a mutual fund. Mutual funds are best visualized as a basket of investments. They can hold many types of assets and are often seen as a way to easily diversify your investments. For example, mutual funds can be money market funds, bond funds, or stock funds. In particular, target-date mutual funds usually hold a handful of mutual funds that themselves hold stocks, bonds, or other assets.

Target-date funds may have a different name depending on the brokerage you use. Thrift Savings Plans (TSPs) call them life-cycle funds, and Fidelity calls them Freedom funds.

Target-date funds aim to make investing with the goal of withdrawing your money easily at a particular date in the future. Investing for retirement is a common use for these funds. You can use them for any goal you want, though. Other goals could include saving for college or purchasing a home.

How target-date funds work

Target-date funds normally invest in a basket of other mutual funds or ETFs. For this reason, they may sometimes be referred to as a "fund of funds." They aim to match the risk tolerance the fund believes you should have when you are a certain number of years from your goal date, which is often your retirement year of choice.

The allocation, or mix, of the fund's underlying investments, is often more aggressive if you have a longer period until reaching your goal. As the goal moves closer, the fund moves the target allocation to a less risky mix. The lower the risk profile by selling more aggressive investments and buying more conservative investments.

The move from a more aggressive investment allocation to a less aggressive mix is called a glide path. Funds often show a visual representation of their intended glide path within the material describing the investment.

The glide path is designed based on the target date. It aims to minimize risk as you get closer to your target date. When you retire, your fund may transfer into a retirement income fund or may continue as the target date fund with a conservative investment mix.

Target-date funds are generally named based on the date when you expect to need your money. Someone investing to retire in the year 2050 would select a 2050 target-date fund. Mutual fund companies don't have a target-date fund for every year, though. They typically create target-date portfolios in five-year increments.

For example, Vanguard offers the Vanguard Target Retirement 2045 Fund (VTIVX), Vanguard Target Retirement 2050 Fund (VFIFX), and Vanguard Target Retirement Date 2055 Fund (VFFVX). If your expected need date doesn't match up precisely with one of these years, you can pick the date that best suits your investing goals.

Pros and cons of target-date funds

As with any investment product, target-date funds have benefits and drawbacks. Whether they're a good fit for you depends on whether the pros outweigh the cons when you look at them compared with your investment objectives.

Pros of target-date funds

Simple way to pick an investment: It's extremely easy to pick a target-date fund investment as long as you agree with the target-date fund's glide path and investment choices. All you have to do is find the target date fund that's closest to the date when you want to start accessing your money.
Automatically changes risk level as the target date nears: Target-date funds publish their glide path. This displays how the investment management changes as your target date approaches. They automatically adjust your portfolio from a higher-risk allocation to lower-risk investments as you get closer to when you need your money.
Could be a one-fund solution: If your only goal for your investments is funding retirement, a single target-date fund that you thoroughly investigate might be the only investment you need. Of course, you should evaluate all your options before deciding whether this fits your situation.
Can be a diversified investment option: Most target-date funds include diversification across a mix of stock and bond-focused investments. The allocation and diversification of stocks and bonds change as your target date nears but should remain well-diversified based on the fund's glide path.

Cons of target-date funds

There are fees on top of fees. Target-date funds have an expense ratio, or costs, to manage the fund. The investments within target-date funds usually consist of other mutual funds and ETFs. These investments have their own expenses and expense ratios. That means your fund of funds could end up having you pay fees on top of fees, which lowers your returns. People who are comfortable managing their investments and moving themselves to a more conservative asset allocation as they get closer to retirement can invest on their own in the same funds a target-date fund does. This can help them avoid the extra fees the target date fund charges.
Glide paths may vary from product to product. Every target-date retirement fund family is different. Although Vanguard's target-date funds may all have similar glide paths based on the number of years until you reach your goal, Fidelity's Freedom funds may have completely different glide paths. You must examine each fund's glide path to make sure it fits your risk tolerance and goals.
Glide paths may not fit your risk tolerance. Target-date funds generally have a large percentage of their investments in stocks and riskier asset classes early in a target date fund's existence. If you're incredibly risk-averse, a target-date fund may not be a good fit for you. Similarly, people who wish to take more risk as they get closer to their goal date may not like how conservative a target-date fund's allocation gets as the target date nears.
Target-date fund returns are not guaranteed. Not only are target-date funds not guaranteed, but you could also actually lose money. Your return will depend upon how the assets in the fund are allocated by the fund manager and how the underlying funds or other assets held by the target-date fund perform.
It may not work well if you change your target date. Life happens, and people regularly change their goals. Last-minute changes to your timeline can drastically impact your target-date fund investment. If you end up needing the money early, the target-date fund may invest your money too aggressively. It could end up declining in value right before you need it. If you delay your target date, the conservative investments in a target-date fund may depress your returns when you need your money to grow the most.

How to invest in target-date funds

You may be able to invest in target-date funds today. Many 401(k)s and other workplace retirement plans offer target-date funds as an investment option for plan participants. If you have a brokerage account, you normally have several target-date fund options to choose from.

People who want to invest in a particular target-date fund family, such as Vanguard's, may find it the least expensive to do so by opening a brokerage account directly with the firm offering the fund. To invest in a target-date fund, you may need to have a minimum initial investment, such as $1,000. Other target-date funds may not have a minimum initial investment amount, such as Fidelity's Freedom fund offerings.

FAQs about target-date funds

Do target-date funds pay dividends?

Although every target-date fund works in different ways, most target-date funds do pay dividends. Most pay dividends once per year. Check the fund's summary prospectus to see when distributions are typically made. Even if a fund regularly made dividend payments in the past, it may not have to continue paying out dividends.

What is a good expense ratio for a target-date fund?

Each mutual fund charges its own expense ratio. In an ideal world, expense ratios would be as close to zero as possible. This way, you could keep more of your money. These funds do have expenses, though, so you should expect to pay a minimal expense ratio.

Some funds charge expense ratios of almost 1%. You should avoid these funds unless their performance more than makes up for the expense ratio. Vanguard offers low-cost target-date funds — their expense ratio usually hovers around .10%. Vanguard also states the average expense ratio of similar funds generally falls at .60%.

What is in a target-date fund?

A target-date fund's asset allocation typically consists of mutual funds from the company offering the fund. This is certainly the case with the largest companies offering target-date funds, including Vanguard, Fidelity, T. Rowe Price, and the American Funds. In some cases, the target-date fund might hold outside mutual funds or other underlying investments.

The manager of the target-date fund will decide how each TDF in the family for each target date is allocated over time. The allocations will be made from among the mutual funds held inside of the TDF.

Can you take money out of a target-date fund?

Yes, you can take money out of a target-date fund. You do this by selling your shares of the fund. Then you can take the proceeds and put them in another investment or leave it in cash. Read the fund's prospectus to see whether you have to pay any fees for selling the asset.

A target-date fund is different from a retirement account like a 401(k) or an IRA, where there can be an early withdrawal penalty if you withdraw funds prior to age 59 1/2. 401(k) plans that use a target-date fund as their default option go out of their way to communicate that customers are free to move the money out of the target-date fund if and when they so desire.

Bottom line

When learning how to save for retirement, you probably have come across target-date funds. They provide you with an easy way to start investing for a goal based on the date you want to achieve that goal.

Offerings vary from target-date fund to target-date fund, so it's essential to learn about the investment, its glide path, and the fees for investing in it. Make sure you evaluate your overall portfolio's asset allocation at least once per year if you invest outside of a target-date fund to account. Doing so can help you account for any glide path changes over time and perform any rebalancing you need to do on the rest of your investments to keep a healthy and diversified portfolio.

Ultimately, you must decide whether the pros of investing in a target-date fund outweigh the cons. If they do, researching and picking the best target-date fund may be a smart move. People who decide against target-date funds may find that building their own portfolio of index funds, mutual funds, or ETFs works best for them. For those uncomfortable with the idea of choosing the right target-date fund, using a robo-advisor or financial advisor may better fit their needs.