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What is a target-date fund?

A target-date fund provides instant diversification and automatic rebalancing to put your retirement savings to work.

Javier Simon
Javier Simon

Posted

Fact checked

A target-date fund (TDF) is a diversified investment vehicle that is automatically rebalanced to invest in safer securities as you get closer to retirement. This approach can make it a reliable savings option for hands-off investors, but it has some drawbacks.

What's in this guide?

What is a target-date fund?

A target-date fund (TDF) is an investment vehicle designed to generate long-term returns while minimizing risk. Early in your career, a TDF primarily invests in growth-oriented securities like stocks. As you near retirement age, it is automatically rebalanced to invest more heavily in bonds, money market funds and other potentially safer investments.

TDFs are known as “funds of funds.” This means they invest in shares of various stock and bond funds.

TDFs are common investment options in most 401(k) plans. In fact, you may already be invested in one. A TDF is a common default investment in these plans. TDFs are also called lifecycle funds and target retirement funds.

TDFs are typically named after the “target year” that you plan to retire. For example, you may be invested in TDF 2056 if you plan to retire that year. However, fund companies typically roll out TDFs in five-year increments. So you should consider one named after the year closest to your desired retirement age.

Target-date fund example

When you open a TDF, it may invest 90% of its asset allocation or investment mix in domestic and foreign stocks. But as you get closer to retirement age, your TDF may shift more of its allocation to bonds. For example, TDF 2056 may invest 70% of its asset allocation in bonds and other fixed-income securities when that year comes. The progression is known as the fund’s glide path.

How to invest in a target-date fund

While TDFs are most commonly associated with retirement plans, there are many ways to invest in these funds.

  • 401(k) plan: Many 401(k) plan providers offer you a lineup of TDFs managed by large financial institutions like Vanguard and Fidelity.
  • Traditional or Roth IRA: You can open an IRA with most brokerage firms and banks. From there, you can choose the TDF that’s right for you.
  • Self-directed brokerage accounts: When you open a taxable brokerage account, you can invest directly in TDFs. But you won’t get the same tax benefits as you would by investing in a TDF through a qualified retirement plan such as a 401(k) or IRA.
  • Directly from investment firms that manage TDFs: You can buy shares of TDFs directly from fund providers. But this move may require large minimum investments.

Pros and cons of target-date funds

Before you invest in a TDF, you should weigh the benefits and drawbacks.

Pros

  • Diversified portfolios
  • Automatically rebalanced
  • Designed to capture growth and minimize risk

Cons

  • You can’t buy and sell funds within a TDF on your own
  • TDFs may perform poorly if you’re heavily invested in stocks during a market downturn
  • Asset allocation glide paths and fees vary across providers

Should you invest in a target-date fund?

A TDF may suit you if you want your portfolio to be professionally managed and rebalanced for you. Active investors may prefer to design their own portfolios by picking which securities to invest in through their retirement plans.

If you’re in between, you can invest in a TDF through your retirement plan while making your own trades through a taxable brokerage account.

Target-date fund fees

TDF costs vary across products and how you invest in these funds. Here are some fees and expenses to look out for.

  • Minimum investments: You usually need to make a minimum investment ranging from $200 to more than $2,000. But this usually only applies if you’re investing in a TDF directly. If you’re making regular contributions to a TDF in your 401(k), a minimum investment typically doesn’t apply.
  • Expense ratio: Every fund has an expense ratio deducted, typically every quarter, from the entire fund by the management company that runs the TDF. The average TDF expense ratio in 2017 was 0.44%, according to the Investment Company Institute (ICI). Expense ratios can vary from as low as 0.1% to more than 1%.

    But keep in mind that TDFs invest in various funds, so you can be looking at multiple expense ratios. You can find the expense ratio of a specific fund by looking at the fund prospectus. You can access these when you review your account online or by requesting one from the provider.

  • Administrative fees: If you’re investing in a TDF through a retirement plan such as a 401(k), the plan sponsor may charge administrative fees. You can find these on your plan document.
  • Management fees: If you’re investing in a TDF through a brokerage account, the brokerage firm may charge an annual management fee for running your account.

Compare brokerage accounts

Before you invest in a TDF through an investment account, compare your choices.

Name Product Minimum deposit to open Annual fee Available asset types
SoFi automated investing
SoFi automated investing
$1
0%
Stocks, ETFs
Put your money to work. Let SoFi build and manage a portfolio for you. Pay zero SoFi management fees.
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Ally Invest Managed Portfolios
Ally Invest Managed Portfolios
$100
0%
Stocks, Options, Mutual funds, ETFs
No advisory fees for automated investing that's professionally managed. Now with a Socially Responsible Investing portfolio option.
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More Info
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Compare up to 4 providers

Disclaimer: The value of any investment can go up or down depending on news, trends and market conditions. We are not investment advisers, so do your own due diligence to understand the risks before you invest.

How to assess target-date funds

TDFs have grown in popularity within the past decade. But make sure you keep certain points in mind before you invest in one.

  • Fees: Expenses vary across different TDFs
  • Asset allocation: Two TDFs named after the same year can have drastically different asset allocations and glide paths. So make sure you know what you’re investing in.
  • Performance: Analyze the performance of your TDF options over the years

Bottom line

TDFs may be the right choice for passive investors who want access to a diversified portfolio that’s automatically rebalanced to reduce risk as they near retirement. But you can invest in a TDF through a brokerage account.

Fees and other factors may impact your returns, so make sure you compare brokerage platforms before you invest in a TDF.

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