Menu Close

Target Date Fund Pros and Cons

Editorial Note: We earn a commission from partner links on Forbes Advisor. Commissions do not affect our editors’ opinions or evaluations.

Everyone knows that they should be saving for retirement, but figuring out how can be tricky. That’s one reason why target date funds have proved to be so popular.

These all–in–one funds offer investors a basket of low-cost, well-diversified stocks and bonds that correspond to their risk tolerance.

Younger investors initially own quite a bit of equities, though the ratio shifts in favor of fixed income as they age. You simply contribute to the account, and the fund takes care of everything else.

“They’re good for people just starting out,” said Eric Beiley, wealth manager at Steward Partners Global Advisory. “You don’t have to worry about rebalancing.”

Nevertheless, target date funds have come in for increased scrutiny recently, thanks in part to poor performance in 2022. Moreover, research has shown that long-term investors may end up with an asset mix that’s not suitable to their needs.

Even if you began with a target date fund, you may not want to retire with one. Let’s take a closer look at the pros and cons of target date funds to help you decide if they’re right for you.

What Is a Target Date Fund?

Investing is confusing. You know you need to own stocks, but which ones? How do you decide whether international equities are appropriate for you?

Then there’s fixed income. Should you go with corporate bonds, or Treasurys? How should you divide up your portfolio among these different asset classes?

Young workers have to make investing decisions like these while scanning a menu of 401(k) fund options when they start their first jobs. Overwhelmed and unconfident, many spend less than an hour deciding on the fate of their retirement savings.

Related: The Best Target Date Funds

Target date funds make the decisions for you. The investor chooses a particular fund from a financial service firm that corresponds to when they think they’ll retire. A 25-year-old in 2022, for instance, may pick a 2060 target date fund.

The investment company packs the target date fund with well-diversified mutual funds and exchange-traded funds (ETFs) that are aligned with the risk tolerance appropriate for the investor’s current age. More than 90% of that 2060 option, for instance, will be held in stocks.

Once you pick a target date fund, you’re on what’s known as a “glide path,” which is a term of art to describe how the fund’s asset mix changes over time.

As you get older, the target date fund will typically shed some of its stock positions in favor of bond holdings. For instance, a 2020 target date fund typically allocates between 40% and 50% in stocks.

The Pros of Target Date Funds

Target date funds have exploded in popularity over the past decade.

About two-thirds of 401(k) plans offered target date funds in 2007, according to recent research by the Employee Benefit Research Institute and the Investment Company Institute. In 2019, this figure was almost 87%.

Just a quarter of retirement savers used a target date fund in 2007, compared to 60% just 12 years later.

A major reason for these gains is that in 2007, the Department of Labor allowed retirement plan sponsors to automatically enroll employees into target date funds upon becoming eligible for company benefits.

Target Date Funds Are Good for Young Workers

Take one of Forbes Advisors’s favorite options: the Vanguard Target Retirement 2060 Fund. It owns four other Vanguard index funds, with roughly 90% of its assets tied up in stocks.

The expense ratio is just 0.08%, meaning your annual costs stay very low.

Young workers have a very long investment horizon. That’s why in the early years of a target date fund, they own mostly stocks, which provide a great foundation for growing returns over the long term.

Target Date Funds Provide Easy Diversification

Investors who choose Vanguard’s Target Retirement 2060 Fund get a strong dose of diversification. Here is the fund’s current allocation:

One fund gives you access to stock and bonds assets, both domestic and international, in one neat package.

Target Date Funds Handle Rebalancing for You

As you age, your risk tolerance typically decreases. But it’s easy for retirement savers to go for years in a portfolio that doesn’t suit their needs.

For instance, a strong bull market could leave you overweight stocks and underweight bonds. A target date fund, however, is structured to rebalance for you.

While the stocks make up 90% of the Vanguard Target Retirement 2060 Fund, they’re roughly 70% of the 2035 version. You could have ignored your retirement account for the first 25 years of your working life, and still be appropriately invested.

The Cons of Target Date Funds

Target date fund ease of use may come with trade-offs. One intuitive consequence is indifference.

“[P]articipants who invest solely through target date funds—the dominant default investment option—are significantly less likely to seek any form of advice throughout the age distribution, raising the possibility that reliance upon defaults crowds out advice seeking,” per a recent working paper published in the National Bureau of Economic Research.

That is, savers get conditioned to believe that their needs are being met by the target date fund, and are unaware that despite the broad positives for target date funds, there are issues to consider as they get closer to retirement.

Some of these issues include:

Target Date Funds Can Be Too Broad

Target date funds are more like buying a suit from Men’s Wearhouse than Savile Row.

Roughly 60% of offerings are off-the-shelf, according to Morningstar research, and 80% of target date assets are managed by just five companies—American Funds, BlackRock, Fidelity, T. Rowe Price and Vanguard.

Workers across income brackets, then, are offered the same plan despite their income. That’s a problem because the retirement savings needs of someone in retail sales (typically salary: $38,000) and someone in finance (typically salary: $81,000) are different.

Lower wage workers can replace a greater share of their income with Social Security than those with higher pay, which therefore allows them to ramp up their stock allocation without fear of jeopardizing their retirement income.

Nevertheless, a Gap sales clerk will have 46% of their target date fund invested in equities at 65, according to Morningstar, while the insurance salesman trader will have 47%.

Target Date Funds Can Be Too Conservative

Research by academics at University of Illinois at Urbana-Champaign and MIT found that, on the whole, target date funds start becoming too conservative for most people around the age of 50.

Using a complicated model, they found that a typical upper-middle class couple without access to family wealth should put 80% of their portfolio in stocks at age 45 and then decline to a steady 60% at and during retirement.

Target date funds, according to the report’s authors, do a good job of stock ownership for a while—with a typical 75% equity allocation at age 50—but become too conservate thereafter, with a 50% stock holdings at retirement which then declines to between 30% and 40% in later years.

Too Many Fees

Not only might you end up on a glide path that doesn’t fit your specific needs, but you might have to pay more for the pleasure of doing so.

Take the Fidelity Freedom 2060 Fund, a well-regarded target date fund with a 0.75% expense ratio. Investors, though, can achieve a similar level of diversification by owning four separate Fidelity index funds at a fraction of the cost.

Total annual expense ratio fees for these four funds would amount to 0.16%—although you’d need to rebalance your portfolio yourself. That’s just more than one fifth the expense to own the Fidelity Freedom 2060 Fund.

Why pay more for a fund that you may not even want in a few decades?

Should You Invest in Target Date Funds?

The most important thing in saving for retirement is to actually save for retirement. Getting into the habit of putting away 10% to 15% of your pay, or even half of every raise, is more important than selecting the exact right investment vehicle.

Therefore you needn’t nix your target date fund for something else, especially if you’re toward the beginning of your career.

“It’s a great default option for new investors,” said Keith Barberis of Barberis Wealth Management.

Once you start accumulating serious assets, perhaps around $100,000 per Barneris, or reach your 50s, it’s time to reconsider your options. You don’t want to end up with an asset allocation that won’t actually help you achieve your specific retirement income goals.

Consider enlisting the services of a fee-only certified financial planner to help you not only pick the best retirement portfolio for you, but also understand how those assets fit into your larger financial plan.

You don’t want to be left stranded by a glide path that wasn’t right for you.

Looking For A Financial Advisor?

Get In Touch With A Pre-screened Financial Advisor In 3 Minutes

Looking For A Financial Advisor?

Get In Touch With A Pre-screened Financial Advisor In 3 Minutes