What Is a Target-Date Fund and Should You Invest in One?

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 are staple offerings in many employer-sponsored retirement plans such as a 401(k) or 403(b). However, target-date funds are not limited to these types of retirement savings plans. Although target-date funds are designed with saving and investing for retirement in mind, investors can invest using a TDF for any reason, including portfolio diversification.

TDFs could be an appealing option if you’re learning how to invest money and aren’t comfortable managing your own retirement investments. However, it’s important to understand that all target-date funds are not created equal.

What is a target-date fund?

Target-date funds are mutual funds that are managed in terms of the asset allocation toward a target date. For example, Vanguard offers TDFs with target dates ranging from 2020 to 2065 in five-year increments as well as a Target Retirement Income Fund.

Target-date funds are managed accounts designed to help investors save for their retirement. They could be appealing to those who are uncomfortable managing their own investments for retirement.

How target-date funds work

It’s important to understand that all target-date funds are different, even those with the same target dates. No two providers of TDFs approach things in the same way.

The manager of the target-date fund family will determine the asset allocation of the funds at different points in time based on their best judgment and analysis for investors at various points in time.

For a TDF family offering a fund of funds with target dates ranging from 2025 out to 2065 in five-year increments, the manager will set the allocation for each fund between a mix of stocks and bonds, cash, and other investments for each target date year. The allocation will gradually decrease over time as the fund’s target date gets nearer.

Target-date funds will move into their glide path at some point near the target date. The glide path is the point at which the funds move from a more aggressive to a more conservative investment strategy.

TDFs are either “to or through'' retirement regarding the glide path. “To retirement” means the glide path commences on or even before the fund’s target date. Glide paths that are “through retirement” indicate a glide path that starts further into retirement.

Most target-date funds are funds of mutual funds. In other words, they invest in several mutual funds, usually those offered by the company offering the target-date fund.

4 things you need to know about target-date funds

1. 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.

2. Target-date funds are not all the same

Funds with similar target dates offered by different fund companies will differ from one another. This is because the underlying investments will be in a different set of mutual funds. Additionally, target-date funds with the same target date from different fund companies will be managed differently from one another. This includes the asset allocation leading up to the target date as well as when the glide path commences.

3. Expense ratios vary widely

Expense ratios can also vary widely among different target-date fund families. The expenses incurred by target-date fund investors are a function of the expenses of the underlying funds held by the target-date fund and any additional management fees charged by the fund. As with any type of mutual fund, the expenses charged by the target-date fund could impact your return.

4. You can invest in the target-date fund of your choice

You are not obligated to invest in a target-date fund that corresponds to your age or time until your normal retirement age. You are free to invest in any target-date fund with the target date of your choosing.

For example, if the target-date fund that corresponds to your normal retirement age is a 2040 fund, you are free to invest in a 2055 fund or a 2025 fund if either is a better fit based on your investing goals and risk tolerance.

If you are a participant in your company’s 401(k) plan and don’t make an investment selection, many plans will default your contributions into a target-date fund with a target date that corresponds to your normal retirement age.

FAQs about target-date funds

Bottom line

Target-date funds could be an easier way to save for your retirement goals or as part of a larger retirement investment strategy. It could also appeal to those uncomfortable allocating their own investments, or who want a fund on autopilot.

TDFs take some work, however, because not all TDF fund families are created equal. There are differences in the underlying expenses of the funds, the quality of the underlying mutual funds the TDF invests in, and the quality of the management of TDFs.

If you have other investments, you will need to understand how the allocation of the TDF works with your investment objectives and building a diversified portfolio. Target-date funds can be a part of nearly any investment strategy, but they are not the simplistic investment vehicle they are often portrayed to be.