What Is a Target-Date Fund?

Way back when I was a tiny baby personal finance writer, there was a relatively new entrant on the retirement scene. Always exciting!

The idea, in a nutshell, was a type of investment fund that would contain a mix of assets and act as a ready-made portfolio for retirement savers. It was like the breakfast bar of finance. All your financial vitamins and minerals in one tasty package that could tide you over until retirement.

These one-and-done funds went by different names, such as lifecycle fund age-based fund. But generally target-date fund is the term that's stuck, because each fund is labeled according to the target year when the investor hopes to retire. So, if you plan to retire in 2045, you'd select a target-date fund for 2045.

Comparing these funds to a breakfast bar is not far off. Each target-date fund contains a mix of investments at point A, when you start investing, and is designed to shift that mix over the years so that you enjoy a nutritionally balanced combination of assets that will help your savings grow, and (ideally) protect your money from losses.

But you, the investor, don't have to do the heavy lifting. The fund managers (and their sophisticated algorithms) do all the work. This is why target-date funds are sometimes called "set it and forget it" investments.

That's not to say you should set and forget anything that has your hard-earned money in it. But owing to their relative simplicity, these funds have become a common, off-the-rack investing option for many people. About 85% of 401(k) plans offer target-date funds, and 61% of employees in their 60s own a target-date fund, according to a recent analysis of 401(k) plans by the Employee Benefits Research Institute (EBRI).

Their popularity is also the result of financial regulations that have rolled out in the last 20 years or so, permitting company plans to offer target-date funds to employees. In some cases, the company can also channel your money into a target-date fund as a default, if you forget (!) to select your own investments. (P.S. Don't forget to do that.)

So, in case you already own one of these funds and don't know much about it — or didn't know you had one — let's look under the hood and see how they get you from point A to point R (Retirement).

One of the basic tenets of retirement saving/planning is to take on more risk by investing more in stocks when you're younger, so your money has time to grow — but also has time to recover from any losses. Then, as you get older, you can invest more conservatively, with the hope that your savings will still be pretty robust when you retire and start taking withdrawals.

You don't have to agree with this strategy — not everyone does. But target-date funds are built along that general trajectory.

Each target-date fund is designed to adjust the mix of investments over the years (a.k.a. rebalance your asset allocation, as the pros say), so your portfolio is invested for growth at the outset and gently retreats into more stable, less risky investments as you get closer to needing that money in retirement.

How does that work?

Let's start with the target date, mentioned earlier. You start by identifying a likely date for the year you'll retire, and pick a fund that's on or close to that date. The fund typically has the target retirement year in its name, usually in five-year intervals.

So, if you're 45 and want to retire at 70, your target date would be in about 25 years — so you might start figuring out how to allocate your assets by considering a target-date fund 2050.

[Note: Depending which financial behemoth runs the fund (BlackRock, Fidelity, Vanguard, etc.), the actual name of the fund could be anything. Dreamtime 2055. Who knows? But generally you know you're looking at a target fund when they stick the date on it.]

Then you make deposits (a.k.a. contributions) to the target-date fund in your retirement account. The well-paid people running the fund keep an eye on the time, and adjust your portfolio according to the predetermined trajectory, which is known as the glide path.

Not only is "glide path" a charming phrase — I always think of a paper airplane, gently swooping lower as it lands — it helps to illustrate the long-term investment roadmap for the target-date fund overall.

Speaking very broadly here:

Your target-date fund might start out with a portfolio that's 80% in stocks, 20% in bonds and/or cash.

• Some years later, the portfolio might rebalance to 60% stocks, 40% bonds/cash.

• By the time you retire, the mix could be 20% stocks and 80% bonds/cash.

• Those percentages are hypothetical, but you get the idea.

One big question to ask, if you're looking at one of these funds, is whether the glide path ends in the actual retirement year (that is, makes no further adjustments to the portfolio), or does it continue to coast for a few more years, continuing to adjust as it goes? There's no right answer here, but it's something to consider in light of your own plans (you may retire sooner or later).

Target-date funds have their pros and cons, like everything else on Earth.

• Low maintenance. These funds are designed to help investors overcome an innate flaw: their own inertia. Left alone with their money, most people choose to do . . . nada. That's OK in this case, because TDFs are anchored on the premise that you won't do anything! The fund does the grunt work, choosing investments and adjusting your allocation over time.

• Low priced. TDFs have become relatively cheap. The average annual expense ratio was about 0.32% in 2022, according to Morningstar, an industry research and ratings company, down from 0.46% in 2018. Still, always ask about your all-in costs, because fees add up over time to thousands of dollars that you could otherwise put toward a sailboat or a roof repair.

• Easy access. Target-date funds are widely available these days. Whether you're in a company plan, or managing your own IRA through a broker, almost anyone can buy shares of a target-date fund.

• Flexibility. You can withdraw your money from a target date fund at any time. Your money isn't locked up until the target date. You may decide to transfer your money to a different fund, or a mix of funds that you've picked that make more sense for you.

• Can't change it. The investment mix (the asset allocation) in a TDF's portfolio is fixed. If you don't like the investments chosen by that fund, look at a different one, or consider creating your own DIY portfolio — but you can't change what's there.

• Fixed trajectory. Same thing with the glide path. If you'd like to stay invested in stocks for a longer or shorter period, you can't change it (although, again, you can switch funds). This is an especially important consideration given longer lifespans.

• Limited strategy. These funds don't consider the economic climate or personal risk factors; they just chug along a predetermined track, according to your target retirement date. If things change and you need or want to adjust your retirement strategy, you might have to exit the fund. Otherwise, like a breakfast bar, what you see is what you get. Hope you like raisins.

• Confusing end point. Target-date funds are designed to end at the target year, though some continue to adjust the mix of investments for a few more years. Be sure to pay attention to whether your fund goes "to or through retirement" as you may want to roll over the funds if you prefer a different allocation at that point.

There's no question that target funds have limitations. Their lack of flexibility could be a problem for some investors (particularly those who are living longer and need more growth from their portfolios).

But target funds offer a well-designed, long-term portfolio for people who might otherwise stall out if they had to pick their own mutual funds, or decide whether small-cap equities are a good call right now.

Given that the scientific research on investor behavior shows, time and again, that automation is one of the best ways to outsmart inertia, you could do a lot worse than investing in a fund that covers all your bases for you. Mostly.

M.P. Dunleavey writes about life and money, as she has for many years, in countless publications (and a book). She lives in New York City with her family and two cats. Read More