How to Invest in Target-Date Funds

Target-date funds are good choices for saving for retirement—and they’re popular choices, too. In fact, target-date funds are often the default option for people who invest in company-sponsored 401(k) plans.

Why are target-date funds good investments for 401(k) investors and others saving for retirement? There are a few reasons;

• It’s easy for people to choose a target-date fund from their retirement plan: They simply choose the fund with the “target date” closest to their anticipated retirement age.
• Target-date funds provide instant diversification: They blend stocks and bonds in a single portfolio, providing asset-class diversity in one fund.
• Target-date funds require little oversight: They automatically become less risky as investors near retirement, thanks to their “glide paths.”

How Do Target-Date Funds Work?

“Target-date funds” is a catchall term for what are more formally known as target-date strategies. Target-date strategies that you find in 401(k) plans come in one of two investment wrappers: either as mutual funds or as collective investment trusts (or CITs, for short). Whether the wrapper is a mutual fund or a CIT, target-date funds invest in a diversified portfolio of stocks and bonds. The portfolio becomes more conservative as it approaches its target date, following what’s called a glide path.

Although most investors access target-date strategies through company-sponsored retirement plans, people can also invest in target-date funds outside of retirement plans. Most of the largest asset managers—including Vanguard, BlackRock, Fidelity, and T. Rowe Price—offer target-date series. Some of the larger and best target-date series include:

• American Funds Target Date Retirement
• Fidelity Freedom Index
• Fidelity Freedom
• BlackRock LifePath Index
• Pimco RealPath Blend
• State Street Target Retirement
• T. Rowe Price Retirement
• Vanguard Target Retirement

Although target-date funds from one asset manager may have more or less aggressive glide paths than target-date funds from another asset manager, Morningstar research shows that glide paths are converging, which means they aren’t very different from one asset manager to another.

Learn more: What Are Target-Date Funds?

Target-Date Funds: Advantages and Disadvantages

Simplicity is clearly the biggest advantage of investing in target-date funds: By investing in a target-date fund, an investor hands over retirement investment decisions such as asset allocation, fund selection, rebalancing, and the lowering of risk as one nears retirement to a professional asset manager.

Another advantage: Target-date funds generally provide good outcomes, because investors tend to stick with their target-date funds, rather than moving in an out of investments trying to catch “the next big thing.” As a result, the investor returns for target-date funds tend to be better than the investor returns for other types of funds.

What are the disadvantages of investing in target-date funds? Because they are meant to be all-in-one investments, it may be difficult to supplement target-date funds with other funds; investors who do so may unwittingly push their asset allocations out of whack.

Target-date funds also aren’t tax friendly, for a couple of reasons. For starters, they rebalance and reallocate assets on a regular basis, which can trigger taxable events. Also, as these strategies get closer to their target dates, they invest more heavily in bonds, which are tax-inefficient because of their interest payments. As a result, target-date funds are best suited to tax-deferred accounts, like 401(k)s and IRAs. For more about how target-date funds work in an IRA, watch The Best (and Easiest) Investment for an IRA.

How to Find the Best Target-Date Funds

The “best” target-date fund for most investors is the one in their 401(k) plan that is closest to their retirement date.

Those investors who are looking to invest in target-date funds outside of whatever is offered in their 401(k) plan, however, should focus on a few things when selecting a target-date fund.

1. Investors should pick a target-date fund provider that follows a glide path that they’re comfortable with and understand. Pay close attention to the expected exposure to stocks at the target date, as well as what happens after the target date, to make sure they are generally comfortable with the allocation. Compare glide paths across providers—for instance, compare the glide path of a Vanguard fund with the glide path of a BlackRock fund with the same target date.
2. Investors should also examine a target-date fund’s expense ratio to make sure they aren’t paying too much to invest. Target-date funds that invest only in index funds generally have expense ratios around 0.27%, whereas target-date funds that hold only actively managed funds typically have expense ratios closer to 0.82%.
3. Investors can use the Morningstar Analyst Ratings to find the best target-date funds. Review our current ratings in The Best Target-Date Funds for 2023 and Beyond.

Watch: The ABCs of Target-Date Funds

More Target-Date Fund Resources

2023 Target-Date Strategy Landscape