Target Date Funds Pros and Cons: A Comprehensive Guide

Target date funds are a type of investment vehicle designed to help you save for retirement by automatically adjusting your asset allocation as you get closer to your target date.

They work by gradually shifting your investments from stocks to bonds as the target date approaches, which can help reduce risk and increase potential returns.

One of the main benefits of target date funds is that they're easy to understand and require minimal effort from investors, making them a great option for those new to investing.

Target date funds can also provide diversification benefits by pooling money from multiple investors, which can help reduce overall risk.

Target date funds are a type of investment that automatically adjusts your portfolio as you get older. They're a collection of other funds, often referred to as "funds of funds", which own stocks and bonds from various areas, such as large-cap, mid-cap, small-cap, and international funds.

These funds are designed to be hands-off, requiring little supervision, and can grow with minimal effort. You can simply continue sending money into your target date fund on a regular basis, which can be automated.

Target date funds offer a predictable approach to investing, with more predictable returns in the long run due to their automatic adjustments. They're also generally low-cost and tax-efficient.

As you approach your retirement date, the fund will shift its allocation to more conservative investments, such as bonds and cash, and away from riskier investments, like equities. This reallocation is known as the fund's glide path.

The glide path sets the fund's allocation among various asset classes over time, adjusting the mix from more aggressive investments early in the life of the fund to more conservative investments as the fund matures.

Target-date funds can be a useful option for investors who are short on time or don't want to deal with ongoing investment decisions. They offer low minimum investments, allowing for instant diversification among various asset classes.

A professionally managed portfolio is also a key advantage, providing a hassle-free investment experience. This can be especially beneficial for those who are new to investing or don't have the time to research and manage their own investments.

The fees associated with target-date funds can be a drawback, however. Some funds have higher expense ratios, which can eat into your returns. On the other hand, many target-date funds have seen their fees decrease in recent years, making them a more cost-effective option.

Here are some key advantages and disadvantages of target-date funds:

Target-date funds offer instant diversification among various asset classes with low minimum investments.

Professionally managed portfolios provide a hassle-free investment experience.

Low maintenance is another advantage of target-date funds, as they are designed as a one-size-fits-all solution.

Target-date funds provide cost-effective advice, offering investors an element of guidance at a very low cost.

Most target-date funds don't charge an additional fee for this advice, making them a great option for those who don't have an investment background.

The average asset-weighted fee for target-date funds in 2022 was just 0.32%, down from 0.46% five years ago and half of what it was in 2009.

The cheapest 20% of target-date funds saw $54 billion in new inflows in 2022, while the three most expensive quintiles saw outflows.

Target-date funds are associated with good outcomes for their investors, with allocation funds (which include target-date vehicles) faring the best of any major asset grouping.

The owners of allocation funds, including target-date funds, actually enjoyed slightly better returns than the funds' total returns due to positive timing decisions.

This is likely because target-date fund investors tend to stay put, not bothered by the dramatic performance gyrations that stand-alone equity funds can experience.

Here's a comparison of the fees for target-date funds over the years:

Target-date funds may not be the right fit for everyone. A correct investment mix for one person is not necessarily correct for everyone.

Higher expense ratios can be a concern. In some target-date funds, there is a fee for the underlying mutual funds and another layer of fees for managing the funds.

Lack of diversification can also be an issue. If the target-date fund invests only in funds from one particular fund family, this can lead to a similar investment style across the underlying mutual funds.

Here are some potential problems with target-date funds:

Target date funds are a great option for those who want a hands-off investment approach. They automatically adjust their asset allocation based on a specific retirement date.

By doing so, they can provide a relatively stable return over time, as seen in the 7-8% average annual return of Vanguard's LifeStrategy Moderate Growth fund over the past 10 years.

One of the main advantages of target date funds is that they require minimal maintenance and research, making them a great choice for busy investors.

They also offer diversification, as they invest in a mix of stocks, bonds, and other assets, which can help reduce risk and increase potential returns.

For example, the Fidelity Freedom 2050 fund invests in a mix of 60% stocks and 40% bonds, which has historically provided a stable return with relatively low volatility.

Target-date funds are known for their low minimum investments, which allows for instant diversification among various asset classes. This can be a huge advantage for those who are new to investing.

One of the biggest benefits of target-date funds is their low maintenance. They're designed as a one-size-fits-all solution, making it easy to invest without having to worry about ongoing investment decisions.

Asset allocation and holdings in target date funds (TDFs) can vary significantly, especially near retirement age. The Morningstar analysis of prominent TDF series with a 2055 retirement year found that the BlackRock LifePath Index and Dimensional Target Date Retirement Income 2055 funds had 98% and 94% allocated to stocks, respectively.

Investors closer to retirement tend to have more conservative TDFs. For example, the John Hancock Preservation Blend and American Funds Target Date Retirement 2055 funds had lower average allocations of 80% and 84% to stocks, respectively.

TDFs can deviate from their target asset allocation as retirement approaches. Megan Pacholok, senior manager research analyst at Morningstar, noted that TDFs can "kind of deviate a little bit more" when investors are getting closer to retirement.

About 82% of 401(k) plans offered TDFs in 2021, according to the Plan Sponsor Council of America. An average of 28% of 401(k) savings in these plans was held in TDFs, which is a greater share than any other type of investment fund available.

TDFs can differ in their investment strategies and asset allocations, even if they have the same target date. This can affect how risky they are and what they are worth at any given point in time, including when and after you retire.

Retirement planning is a crucial aspect of using target date funds. A 2019 study by Deloitte found that 43% of defined contribution plans, such as 401(k) plans, offered target date funds as an option.

Many employees are automatically enrolled in their 401(k) plans, which invest their contributions in a target date fund by default. This is due to the Pension Protection Act of 2006, which made target date funds a default option for 401(k) plans with automatic enrollment features.

Paying attention to asset allocation is particularly important for retirees, as they generally have larger accounts and may not have time to recover from investment losses. This is why some experts recommend building your own portfolio instead of using a target date fund if your circumstances are significantly different from the average investor.

However, target date funds are still a great option for investors who want an "easy button" for retirement savings. The largest and best-known target date fund managers tend to be relatively similar in their fund allocations, making it a convenient choice for many investors.