Pros and Cons of a Retirement Target Date Fund: Can You Relax and Glide into Retirement?

A retirement target date fund is a kind of mutual fund that is professionally managed and strategically reallocated over time to achieve both growth and security for your assets. The key goal for a target date fund is that your money will be available for withdrawal on a certain future targeted retirement date and beyond.

So, when you invest in a target date fund, you don’t need to worry about what percentage of your money should be in stocks, bonds or TIPS and how that allocation needs to change over time.  A target date fund automatically manages the allocations — buying, selling and strategy for your money.

retirement target date fundIn theory a target date fund lets you kick back, relax and “glide” into retirement.

Relax! “Glide” into Retirement

One of the key features touted by target date funds is their “glide path.” What this means is that the funds will gradually reduce the percentage of your money that is invested in stocks until some point when that allocation levels off, presumably until the fund holder’s death.

For example, if you were 45 now and bought a target date fund, with a target date of 2037 (the year you turn 65), the fund might be allocated like this:

  • 90% in stocks when you are 45, with the rest in bonds and TIPS
  • Gradual reduction in your exposure to stocks starting at about age 55
  • A “glide” toward only about 50% of your money being invested in stocks at 65
  • A continuation of the glide to be about 30% in stocks when you are 75
  • Holding steady at around 30% stocks, 50% bonds an 20% tips for the remainder of your life

The timing and allocation of the glide path can differ widely among fund families. T. Rowe Price’s keeps changing the portfolio allocations until the fund holder is conceivably in their 80s, others in their mid-60s and still others are earlier or later.

In other words, some target date funds glide “to” retirement and others glide “through” retirement.

Whether you are considering keeping money in a target date fund as a rollover from your 401(k) plan upon retirement or directly investing in a target date fund as part of your retirement strategy, you need to understand the fund’s glide path and if this is appropriate for your situation.

How Does a Target Date Fund Work?

The idea behind a target date fund is to make it easier for the average investor to maintain the right kind of asset allocation for their current age as relative to their target retirement age.

To accomplish these goals, the allocation to equities will generally be reduced over time as that target retirement date gets closer.

Sounds like a good idea and it can be. But target date funds are not simple and there are differences even between two target date funds from different fund families with the same target retirement date.

Are There Different Kinds of Target Date Funds?

While there are some differences, most target date funds are structured as funds of funds. In other words, the target date mutual fund’s holdings consist of other mutual funds.

The “big three” are the three firms who manage most target date funds.  The following three companies manage the about 70% of the assets in all target date funds:

Vanguard’s funds are comprised of different allocations of several of their popular index mutual funds. The Fidelity and T. Rowe Price offerings are mostly active funds, though Fidelity does offer an all-index version as well. Most target date funds are funds of funds of the family offering the fund, but there are some that differ either by using funds from other families, ETFs or other holdings.

Expenses are generally a weighted average of the expense ratios of the underlying funds, but again there are some outliers. For example, there can be load share classes, advisory share classes offering 12b-1 fees as trialing compensation to advisors, etc.

Target date funds became a staple in many 401(k) plans after the 2006 Pension Protection Act in which they were granted a fiduciary exemption if used as a default option by plan sponsors for participants who didn’t make an affirmative election for their salary deferral contributions.

The Pros and Cons of Target Date Funds

All target date funds are not created equal.

If you are looking at investing in a target date fund, understand that a 2025 target date fund from one company might be vastly different from the 2025 fund from another fund company. You need to look under the hood and understand the underlying investments, the asset allocation and the glide path among other things.

Choosing the right fund for your particular goals could be tricky.

Target date funds and other investments

Many 401(k) providers tout target date funds as a single investment for participants. In other words, they suggest that participants who decide to use a TDF consider investing their entire account in the TDF. They do this to keep these participants from having an inappropriate allocation for their needs by adding in other investments that may skew their overall allocation in a direction that isn’t appropriate for them.

Whether you agree or disagree with their approach, they do have a point. If you choose to use a target date fund as part of your retirement investing strategy either prior to retirement or into retirement, you must be aware of the impact of the TDFs’ allocation on your overall allocation.

By the time we reach retirement age it’s likely we will have several accounts invested for retirement and other purposes. These might include an IRA, a spouse’s retirement plan and others. It’s important that the allocation of the TDF that you are considering is factored into the allocation of the investments in these other accounts and that you take a portfolio view of all your accounts.

Does “one size fits all” really work for you?

Target date funds and other types of managed accounts can have merit for those who are not comfortable allocating their own investments or who don’t work with an advisor.

That said do you really want to invest in an account that is one size fits all? Ideally your retirement allocation and investment strategy will be tailored to your individual situation including a withdrawal strategy, tax considerations and others.

How to Choose the Right Target Date Fund

There are a variety of questions you will want to assess for any fund you are considering.

What is your target date?:  If due to your age a target 2020 fund would be the fund suggested for you, there is no rule saying that this is the target date fund that you need to invest in. If you want to be more aggressive you can choose a longer-dated fund, if you want to be more conservative you can go with a fund with a shorter target date.

What company? You probably will want to choose a target date fund from one of the big 3 companies.

What glide path is best for you?  Each fund will publish the details of their investment strategy — including their glide path.  You will want to decide whether or not you want your fund to glide to your target date or through your target date.

How much risk do you want to take? Once you are in the fund, you will need to stick with it.  So make sure that the level of risk in the fund’s investments is appropriate to your goals.

Understand how your other investments impact your financial profile: If you are investing in a target date fund in addition to holding funds in other types of accounts, you will want to make sure that you are comfortable with your overall asset allocations.

Is a Retirement Target Date Fund Right for You?

Target date funds can be a decent option for those looking for a managed account option. Like any other investment decision, you should review and understand the target date fund that you may be considering to determine if it is appropriate for your situation.

You might want to speak with a financial advisor.

Or, try out different investment scenarios in the NewRetirement retirement planner.  After setting up your account, you can try different scenarios and immediately see how different options impact your overall financial health.

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