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

Target-date funds offer an attractive option for investors who don’t want to manage their own retirement savings.
Last updated April 3, 2023 | By Roger Wohlner Edited By Michael Kurko
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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.

In this article

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

How does a target-date fund work?

Target-date funds are generally offered as a group of funds with target dates that range from the present to 40 or more years, typically with separate TDFs in five-year increments. The fund invests towards the fund’s target date, with a higher allocation to stocks the further away from the target date you are. The allocation to stocks will gradually decrease over time as the target date gets closer.

What is the advantage of a target-date fund?

The manager of a target-date fund allocates the underlying investments, usually mutual funds, in a manner they deem appropriate for the period of time remaining until the target date. As a result, they might appeal to those who aren’t comfortable selecting their own investments from the menu of options offered by the plan.

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?

You can take money out of a target-date fund because they are no different from any other type of mutual fund.

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

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.

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Author Details

Roger Wohlner In addition to his bylined articles on sites like TheStreet, ThinkAdvisor, and Investopedia, Roger ghostwrites extensively for financial advisors, investment managers, and financial services companies.