A worker who enrolls in a 401(k) may be offered a fund labeled with a future year, such as 2045 or 2060. These are target-date funds, investment products designed around an approximate retirement year.
Their appeal is straightforward: one fund can hold a mix of investments and gradually adjust that mix as the target date approaches. But the year in the fund's name does not guarantee a particular retirement result.
How Target-Date Funds Are Built
A target-date fund typically invests in a combination of stock funds, bond funds and sometimes other investment holdings. The manager sets an asset allocation based on the fund's target year and an investment strategy.
A fund aimed at someone retiring decades away may hold a larger share of stocks. As the target date approaches, the fund generally shifts toward a more conservative mix, often increasing its exposure to bonds and other less volatile investments.
This gradual change is known as the glide path.
"To" and "Through" Strategies
The SEC distinguishes between two common glide-path approaches.
A "to" fund generally adjusts its investment mix until the target date and then levels off. A "through" fund continues adjusting its allocation after the target date, reflecting the idea that retirement may last many years.
Neither approach is automatically best. Someone who expects to keep working after the target year may have different needs from someone planning to withdraw a large portion of the account soon after retirement.
The Target Year Is Not a Guarantee
A target-date fund does not promise a specific balance or protect an investor from market losses. If stock and bond markets decline, the fund's value can fall even when the retirement date is close.
Two funds with the same target year can also have different investment mixes, fees and glide paths. Investors should not assume that the year in the name makes competing funds identical.
The SEC advises investors to examine the fund's strategy, risk level and investment approach rather than relying only on the target date.
Fees and Underlying Investments
Target-date funds may invest in other funds, which means investors should understand both the overall expense ratio and the costs of underlying holdings where relevant.
Fees reduce investment returns over time. A fund with a higher expense ratio needs stronger performance just to match the result of a lower-cost alternative, all else being equal.
The fund's prospectus can explain its holdings, strategy, risks and expenses.
A Convenient Option That Still Needs Review
Target-date funds can simplify retirement investing, particularly for workers who do not want to manage several funds themselves. But convenience does not remove the need to check whether the fund is appropriate for the investor's circumstances.
An employee should consider other retirement accounts, outside investments, expected retirement income, risk tolerance and the timing of withdrawals. Someone with substantial investments elsewhere may already have a different overall asset allocation from the one shown inside the target-date fund.
The Bottom Line
Target-date funds provide an automatic investment mix that changes over time, but they are not all alike and do not guarantee a retirement outcome. Investors should review the glide path, fees, underlying holdings and risk level before choosing a fund. The target year is a starting point for evaluation, not a substitute for understanding what the fund owns.
This article is for informational and educational purposes only and should not be considered personalized financial, investment, or tax advice.
