The Pros and Cons of Target Date Funds for Retirement

Target-date funds offer a hands-off approach to retirement investing by holding a diversified mix of investments that gradually becomes more conservative as a specified retirement year approaches. The pros and cons of target-date funds often center on this simplicity: Investors get automatic asset allocation and rebalancing in a single fund, but they have less control over individual investments and may pay higher fees than they would by building a portfolio themselves. Comparing these trade-offs can help investors determine whether a target-date fund fits their retirement strategy.

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What Is a Target-Date Fund?

A target-date fund is a mutual fund or ETF built around a specific retirement year, which appears in the fund’s name, such as a “2050 Fund.” You choose the fund matching the year you expect to retire, then contribute to it over time.

Each fund holds a diversified mix of assets, typically stocks, bonds, and cash equivalents. Early on, it leans heavily toward stocks for growth. As the target year nears, the fund automatically shifts to more conservative holdings like bonds, following a preset schedule called a “glide path.” This gradual rebalancing continues until the target date, and sometimes beyond it.

The fund manager handles all allocation adjustments, so the investment mix evolves without any action required from you.

Advantages of Target-Date Funds

Target-date funds are designed to simplify retirement investing and reduce the number of portfolio decisions investors need to make. For people who don’t want to actively manage their investments, that can offer several advantages.

Less Hands-On Portfolio Management

Investing in a target-date fund is an approach to retirement saving that’s partly designed to save you from yourself. Investors don’t have to decide how much to allocate to stocks and bonds or regularly rebalance those investments on their own.

That hands-off approach can also reduce opportunities to tinker unwisely with a retirement portfolio, such as buying stocks after prices have risen or selling during a market downturn. Investors can continue contributing while the fund manager handles the portfolio’s allocation.

Built-In Diversification

One of the defining features of a target-date fund is how widely it invests. A single fund usually holds a blend of stocks, bonds and other assets, and depending on how it’s structured, that blend can reach across various sectors, companies of different sizes and markets both in the U.S. and abroad.

For the investor, this means an entire spread of holdings comes packaged into one purchase, with no need to research, buy and monitor dozens of separate positions. Spreading money this way is no guarantee against losses. What it does offer is protection against the danger of tying a retirement to the fate of only a few investments.

Risk Adjustments Over Time

Target-date funds also manage how much investment risk the portfolio takes as retirement approaches. Investors generally have more exposure to stocks when retirement is decades away, providing greater potential for long-term growth, and more exposure to bonds and other relatively conservative investments later.

This can be particularly useful as retirement approaches, when investors have less time to recover from a major market downturn. The fund makes those adjustments automatically rather than relying on the investor to decide when and how much to change the portfolio.

Simple Investment Selection

Putting together a retirement account often means weighing one fund against another, settling on the right mix of assets and thinking through how all those pieces fit together. A target-date fund folds those choices into a single decision.

For someone who would rather keep things uncomplicated, picking a fund that lines up with an expected retirement year takes far less effort than assembling a portfolio piece by piece and tending to it over the years.

Disadvantages of Target-Date Funds

The simplicity of target-date funds comes with trade-offs. Investors give up some control over their asset allocation, and a fund’s predetermined investment strategy may not account for their complete financial situation.

Limited Control Over Asset Allocation

Target-date funds adjust their investment mix according to a preset glide path, but investors with the same expected retirement year don’t necessarily have the same financial needs or risk tolerance.

For example, an investor concerned about longevity risk, or the possibility of outliving their retirement savings, may want more exposure to stocks and their potential for long-term growth. Another investor may prefer a more conservative allocation. A target-date fund does not make these adjustments based on an individual’s circumstances.

Different Funds Take Different Approaches

Two target-date funds aimed at the same retirement year can look surprisingly different under the hood, with distinct asset allocations and glide paths. Certain funds keep adjusting their mix well past the target date, while others arrive at their most conservative point right around the time an investor stops working.

Because of this, the year attached to a fund’s name doesn’t reveal how much risk it actually carries. A closer look at what a fund holds and how its glide path is designed offers a better sense of the way it manages risk in the years leading up to retirement and throughout it.

Fees Can Reduce Returns

Like other funds, target-date funds charge fees that reduce investment returns. Because they often invest in other mutual funds or ETFs, investors should consider the fund’s overall expense ratio and how it compares with alternative ways to build a diversified portfolio.

Costs vary considerably among target-date funds, so fees may be a relatively minor drawback for some funds and a more significant consideration for others.

They Don’t Account for Your Other Investments

A target-date fund manages its allocation with no awareness of what you own anywhere else. If you also hold stocks, bonds or other investments in an IRA, a taxable brokerage account or another retirement plan, the fund won’t take any of that into account when setting its own mix.

The effect is that your portfolio as a whole could end up more aggressive or more conservative than you had in mind. Anyone juggling several accounts may need to step back and assess their asset allocation across everything they own, instead of judging the target-date fund on its own.

Target-Date Funds Can Still Lose Money

Target-date funds provide diversification and generally become more conservative as retirement approaches, but neither feature guarantees against losses. Their underlying stocks, bonds and other investments can decline in value, including around the target retirement date.

A target-date fund also does not guarantee that an investor will have enough money to last throughout retirement. Contributions, withdrawals, investment performance and retirement length can all affect how long those savings last.

Bottom Line

Down the road, workers may be able to choose a long-term life cycle fund that keeps the best parts of the target date fund (you can “set it and forget it,” and the fund manages your risk as you age) while smoothing out some of today’s rough edges. A fund like that might rebalance more often, aiming to capture more of the upside when markets climb and cushion the blow when they fall. For now, though, a low-fee target-date fund may be a solid choice for anyone who would rather not tinker with their own retirement investments.

Types on Investing for Retirement

Consider working with a financial advisor if you need advice on how to invest and plan for retirement. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Retirement accounts such as 401(k)s and IRAs can offer tax benefits that may help your savings grow more efficiently. If your employer offers a 401(k) match, contributing enough to receive the full match can be especially valuable.
Expense ratios, advisory fees and trading costs can reduce long-term returns. Investors may also benefit from considering which investments they hold in taxable versus tax-advantaged accounts, since interest, dividends and capital gains can receive different tax treatment.