Target-Date Funds—Find the Right Target for You

How best to save and invest for your retirement is a matter to be considered carefully. One increasingly popular investment option is target-date funds, sometimes referred to as life-cycle funds. According to one report by a large retirement plan provider, target-date funds are offered by nearly 90 percent of employer-sponsored defined contribution plans, such as 401(k) plans.

Why Target-Date Funds?

Target-date funds are designed to help manage investment risk. You pick a fund with a target year that is closest to the year you anticipate retiring, say a "2050 Fund." As you move toward your retirement "target date," the fund gradually reduces risk by changing the investments within the fund. That said, target-date funds are not risk free, even when the target date has been reached.

An investor survey on target-date funds sponsored by the Securities and Exchange Commission (SEC) found that many survey respondents had misconceptions about these funds and the risks they involve. For example, a majority of investors surveyed did not understand that target-date funds do not provide guaranteed income. Many investors also did not realize that similar-sounding funds may, in fact, have different investments and risk profiles. 

Like all investments, target-date funds can lose money if the stocks and bonds owned by the fund drop in value. And even though funds with identical target dates may look the same, they may have very different investment strategies and asset allocations that can affect how risky they are and what they are worth, at any given point in time, including when and after you retire.

How Target-Date Funds Work

Target-date funds are typically structured as a mutual fund. The particular investments a mutual fund makes are determined by its objectives, which are disclosed in the fund’s prospectus. Most target-date funds are structured as what’s called a "fund of funds," meaning that they invest in other mutual funds rather than in individual securities. For example, a target-date fund could be invested in an equity mutual fund, bond fund and money market fund.  Although many target-date funds use this approach, others invest directly in individual stocks and bonds. In addition, some target-date funds are passively managed, meaning they seek to replicate the performance of their benchmarks—various stock, bond and other indices—instead of aiming to outperform them.

Interested investors may find that target-date funds provide an easy way to hold a diversified investment portfolio that rebalances over time to become less focused on potential growth and more focused on producing income. For example, if the target date is a long time from now, the target-date fund initially will be more heavily weighted toward stock investments—that is, more focused on growth. As the target date approaches, the investment mix becomes weighted more heavily toward fixed-income or cash equivalent investments, including bonds and Treasury securities, which aim for capital preservation and/or income.

A target date fund’s gradual shift to more conservative investments is called the "glide path." A fund’s glide path is generally designed to reduce investment risk over time—but target-date glide paths can vary considerably from fund to fund. Importantly, although stocks have historically provided a higher return than bonds and cash investments (albeit, at a higher level of risk), it is not always the case that stocks outperform bonds or that bonds are lower risk than stocks. Both stocks and bonds involve risk, and their returns and risk levels can vary depending on prevailing market and economic conditions and the manner in which they are used. So, even though target-date funds are generally designed to become more conservative as the target date approaches, investment risk exists throughout the lifespan of the fund and is difficult to foresee.

"To" or "Through" the Target Date

A target-date fund may be designed to take you "to" or "through" retirement. Generally, a "to retirement" target-date fund will reach its most conservative asset allocation on the date of the fund’s name. After that date, the allocation of the fund typically does not change throughout retirement.

A target-date fund designed to take an investor "through retirement" continues to rebalance and generally will reach its most conservative asset allocation after the target date. While these funds continue to decrease exposure to equities throughout retirement, they may not reach their most conservative point until the investor is well past age 65.

Upon reaching their target dates, some target-date funds merge into different funds that typically focus on generating income. If your target-date fund is merged into another fund, read the new fund’s prospectus to determine if it is in line with your investment goals and risk tolerance.  

What You Should Know About Target-Date Funds

If you are thinking about investing in a target-date fund, or already invest in one, there are some important things you should keep in mind:

  • Target-date funds are not guaranteed against losses. Target-date funds contain varying amounts of stocks and bonds. Over time, the value of these investments will fluctuate and can decrease in value, causing your investment in the target-date fund to lose value as well. Target-date funds, however, are typically designed to be diversified investments. In this respect, they may be less risky than investing in individual stocks or bonds, your employer’s stock or some concentrated sector funds (for instance, technology, manufacturing or international sectors).
  • Funds with similar target dates can transition to more conservative investments in different ways and at different times. Target-date funds generally aim to become more conservative over time, but the initial and ending asset allocations of the fund and the rate at which the funds grow more conservative—the glide path—can vary dramatically from fund to fund. This is why you need to pay attention to the glide path and make sure you are comfortable with it and willing to assume the risks associated with following its course. Remember that there is not one right or ideal glide path, and that both the risk and performance of your target-date fund will likely be affected by the glide path planned for the fund.   
  • Combining target-date funds with other investments affects your overall asset allocation. Target-date funds are designed to be standalone investments. In reality, some investors combine target-date funds with other fund choices offered by their plan, or other investments outside their plan. Whatever investments you choose, take the time to understand how your money is invested. Specifically, figure out what percent of your total investment is in stocks, bonds or cash—and compute this allocation periodically to be sure you are comfortable with your allocations. Be aware that by combining a target-date fund with other investments, you may incur more risk.
  • Reaching the target date does not mean you’ve saved enough to meet your goal. Some investors assume that when they reach the target date on the fund, they will have enough money to retire—but this is a false assumption. Whether or not your retirement savings goals will be met will depend on many factors, including the amount of contributions you invest in the fund, the fund’s market performance and other sources of retirement income that are available to you.

Tips for Choosing a Target-Date Fund

Target-date funds were developed to address an important need—helping individuals invest in well-diversified portfolios that rebalance over time for retirement or other long-term goals. Here are some tips to help you make sure the target-date fund you select is, and remains, appropriate for you.

  • Pick your target date carefully. To invest in a target-date fund, investors typically choose the fund with the name closest to the date they plan to retire. An investor who is age 30 and wishes to retire at age 65 might choose a target-date fund with a date close to 35 years in the future. Similarly, a 50-year-old investor planning to retire at age 70 might choose a fund with a date about 20 years in the future. When choosing a target-date fund, take care to select the date that aligns most closely with your retirement investment strategy.
  • Assess how much risk you are willing to take. When comparing funds with similar target dates, examine their investment strategies so that you can select the one that best matches your tolerance for risk. Keep in mind that your circumstances could change along the way, so you should monitor the fund’s performance periodically to ensure it meets your investment goals.
  • Determine whether the fund will take you to or through retirement. Read the fund’s prospectus to understand what the target date actually means and to avoid being surprised by how the fund’s asset allocation changes over time. 
  • Monitor the glide path of your target-date fund. Review the investments of your target-date fund periodically to ensure that the investment manager has not changed the way in which the fund reallocates assets over time. If the glide path has changed, make sure you are still comfortable that the glide path is consistent with your retirement investment strategy and the overall level of risk you are taking.
  • Pay attention if automatically enrolled. If your employer has automatically enrolled you in a target-date fund in its defined contribution retirement savings plan, take time to understand the fund. Depending on your circumstances, you may find that a different option in the plan might be better suited to your retirement savings needs.
  • Keep your "mixed" investments balanced. If you invest in a target-date fund in addition to other funds and investments, make sure you are comfortable with your overall asset allocation. And be prepared to rebalance your overall portfolio periodically based on your needs.
  • Check fees and expenses. Compare different target-date fund fees and expenses using FINRA’s Fund Analyzer. Remember, they make a difference in the long-term performance of your investments.

Get to know your target-date fund. It could prevent surprises down the road and, consequently, leave you better prepared for retirement.