What is a Target-Date Fund?
Target-date funds are designed to maximize returns for investors by a specific date. These funds typically focus on riskier growth stocks in their early years to build gains and then shift to conservative choices as the target date approaches to retain these gains.
Target-date mutual funds are usually chosen by investors saving for retirement but can also be used for other significant future expenses like a child’s college tuition.
Key Takeaways
- A target-date fund is a mutual fund or ETF that periodically rebalances to optimize risk and returns for a set time frame.
- These funds become more conservative as the target date nears, minimizing risk.
- Target-date funds offer the convenience of a set-it-and-forget-it investment strategy.
- They usually mature in 5-year intervals such as 2035, 2040, and 2045.
- Although relatively more expensive than other mutual funds, the expense ratios on target-date funds have decreased considerably in recent years.
How a Target-Date Fund Works
Target-date funds leverage traditional portfolio management strategies to achieve a predetermined investment return by a specific year. Named by the year when the investor plans to use the assets, these funds typically represent long-term investments. For instance, if a fund launched in 2017 has a target date of 2065, it is designed with a 48-year time horizon.
Fund managers use this predetermined horizon to adjust their investment strategy annually based on asset allocation models and the investment’s risk tolerance, which evolves over time.
Special Considerations
Initially, a target-date fund is more weighted towards high-risk, high-reward investments. Over time, as the target date nears, the asset mix becomes conservative, shifting towards fixed-income investments like bonds and cash equivalents.
These changes are often illustrated in marketing materials that indicate the fund’s allocation glide path—the transition from high-risk to low-risk assets over the investment period. Target-date funds that continue to adjust beyond the target date are known as “through” funds, while those that stop adjusting once the target date is reached are called “to” funds.
Today, target-date funds are exclusively available as mutual funds, with no current ETF equivalents.
Advantages and Disadvantages of Target-Date Funds
Advantages
- Simplicity: Target-date funds are popular in 401(k) plans because they simplify investment by allowing workers to select a single fund matching their retirement timeline.
- Convenience: They often serve as a one-stop investment, minimizing the need for other assets.
- Auto-Adjusting: Once selected, these funds manage adjustments automatically.
Disadvantages
- Lack of Flexibility: As personal and financial situations change, the preset investment path may not align with individual needs.
- Market Risks: There is no guarantee of specific income or returns, and these funds may not always keep pace with inflation.
- Higher Costs: They can be more expensive due to their nature as a fund-of-funds, although fee rates are decreasing.
- Variable Fund Compositions: Different target-date funds may have varied asset compositions, which can affect risk levels and performance.
Pros and Cons Recap
Pros
- Simplified, autopilot investment
- All-in-one investment vehicle
- Diversified portfolio
Cons
- Higher expenses than other passive investments
- No income guarantees
- Potentially insufficient inflation protection
- Limited flexibility for changing goals and needs
Example of Target-Date Funds
Vanguard offers an extensive range of target-date funds. Let’s compare the Vanguard 2065 Fund (VLXVX) and the Vanguard 2025 Fund (VTTVX).
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Vanguard Target Retirement 2065 Fund (VLXVX): Expense ratio of 0.15%. As of Q2 2022, the allocation was 90.5% in stocks and 9.5% in bonds. The fund’s holdings include:
- 53.8% Vanguard Total Stock Market Index
- 36.6% Vanguard Total International Stock Index Fund
- 6.7% Vanguard Total Bond Market II Index Fund
- 2.9% Vanguard Total International Bond Index Fund
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Vanguard Target Retirement 2025 Fund (VTTVX): Expense ratio of 0.08%. More conservative with 57.5% in stocks and 42.5% in bonds. Holdings include:
- 34.7% Vanguard Total Stock Market Index Fund
- 27.6% Vanguard Total Bond Market II Index Fund
- 22.7% Vanguard Total International Stock Index Fund
- 12.2% Vanguard Total International Bond Index Fund
- 2.80% Vanguard Short-Term Inflation-Protected Securities Index Fund
Post-target-date, the asset allocation for both funds will shift toward a more conservative mix including approximately 20% in U.S. equities, 10% in international equities, 40% in U.S. bonds, and other safer investments.
Frequently Asked Questions
Can I Hold Onto a Target-Date Fund After the Target Date?
Yes, depending on the type of fund. A “through fund” continues shifting toward conservative investments over time, while a “to fund” stops adjusting at the target date.
Are Target-Date Funds Expensive?
Generally, yes, due to their structure as funds-of-funds and frequent rebalancing. However, many target-date index funds have low expense ratios.
Can I Use a Target-Date Fund in My 401(k) or IRA?
Yes, most retirement plans offer these options. However, it’s generally advised to allocate your savings exclusively in a target-date fund for proper glide path allocation.
What Target-Date Fund Should I Pick If I Plan to Retire in a Year Not Ending in -5 or -0?
Pick the nearest target-date fund, in either direction depending on your risk tolerance. You can also split your investment between two neighboring target-date funds to balance your allocations.
Related Terms: mutual funds, ETFs, retirement planning, asset allocation, fixed income, index funds.
References
- ETF Database. “Target Retirement Date ETF List”.
- Vanguard. “Vanguard Target Retirement 2065 Fund (VLXVX)”.
- Vanguard. “Vanguard Target Retirement 2025 Fund (VTTVX)”.
