What a Target Date Fund Is and Who It Fits Best

You opened your 401(k) or IRA, saw a list of 20 funds, and the one with a year in its name looked like the easy answer. It might be. A target date fund can be the simplest good decision a new investor makes, but it can also be an expensive or badly matched one if you pick it without reading two numbers on the fact sheet.

I write about retirement accounts for people who do not want to spend weekends reading prospectuses. This guide covers what a target date fund holds, how its mix changes over time, what it should cost, and when you are better off building something yourself.

How a target date fund works

A target date fund is a single fund that holds a mix of stock and bond funds, chosen to suit someone who plans to retire around the year in the name. A 2060 fund is built for people retiring around 2060, so it holds mostly stocks today. A 2030 fund is built for people about four years from retirement, so it holds a lot more bonds.

Inside, most are a wrapper around a handful of index funds: a US total market fund, an international stock fund, a US bond fund, and often an international bond fund and inflation protected bonds. If you have read our guide on index funds explained for a first-time investor, you already understand most of what is in the box.

The fund rebalances for you. If stocks jump and push the mix from 90 percent to 93 percent stocks, the fund sells some and buys bonds to get back on track. You do nothing.

The glide path, in real numbers

The schedule for shifting from stocks to bonds is called the glide path. Every fund company draws it a little differently, which is why two funds with the same year can behave quite differently in a bad market. Here is a rough picture of a typical glide path from a large index fund provider:

Notice that the fund does not stop at the target year. Many keep shifting toward bonds for another five to ten years. These are called "through" glide paths. Others hit their final mix at the target date, which is a "to" glide path. The fact sheet will tell you which one you own, and it matters a lot if you plan to retire exactly on that date.

What a target date fund should cost

Cost is where target date funds split into good and bad. The same idea is sold at wildly different prices.

• Index based target date funds from the big low cost providers charge around 0.08 to 0.15 percent a year.
• Actively managed versions often charge 0.40 to 0.75 percent.
• Some funds inside small employer 401(k) plans charge 1 percent or more once plan fees are added.

On a $50,000 balance, 0.12 percent costs $60 a year. One percent costs $500. Over 30 years of growth, that gap can easily become six figures. Our article on expense ratios explained with real dollar amounts walks through the math in more detail. If your plan only offers a pricey target date fund, look for a plain S and P 500 or total market index fund in the same menu instead.

Who a target date fund fits

A target date fund is a strong default for three types of investor:

1. People who want one fund in one account and never want to rebalance.
2. New investors who know they would panic and tinker with a three fund mix during a crash.
3. Anyone in a workplace plan with a low cost target date option, especially if it is the automatic default.

The one rule: own it on its own. A target date fund is designed to be your whole portfolio in that account. If you hold a 2055 fund plus a separate stock fund plus a bond fund, you have broken the fund's balance and you are paying for automatic rebalancing you are not really using.

When I would skip it, despite the popular advice

The standard line is that everyone should pick the fund closest to their retirement year. I think that advice is too rigid. The year in the name is just a risk setting, and your real risk tolerance may not match your birthday.

If you have a solid pension coming, or a spouse with a large retirement account, you may be able to hold more stocks than your age suggests. Picking a fund 5 or 10 years later than your actual retirement year is a simple way to do that. The opposite also applies. If a 35 percent drop would make you sell everything, a fund with an earlier date and more bonds is better than a perfect fund you abandon in a panic.

I would also skip a target date fund in a taxable brokerage account. The bond portion throws off interest taxed at your full rate every year, and you cannot control which assets sit where. In a taxable account, separate stock and bond index funds give you more control. If you are still choosing an account type, start with our guide to what a brokerage account actually is.

Checking a target date fund in five minutes

Before you click buy, open the fund's fact sheet and check these points:

1. Expense ratio. Under 0.20 percent is good, over 0.50 percent needs a reason.
2. Current stock and bond split. Does it feel right for you today?
3. Glide path type, "to" or "through" retirement.
4. Whether the underlying funds are index funds or actively managed.
5. Minimum investment, which is often $1,000 in an IRA and zero inside a 401(k).

Frequently asked questions

Is a target date fund a good investment for beginners?

For most beginners, a low cost target date fund is a sensible choice because it handles diversification and rebalancing automatically. The key is choosing an index based version with an expense ratio under about 0.20 percent. It works best as the only fund in an account.

Can you lose money in a target date fund?

Yes. A target date fund holds stocks and bonds, and both can fall. In 2022, many 2060 funds lost around 18 percent and even funds near their target year dropped more than 10 percent. Time in the market is what lets you recover those losses.

What happens to a target date fund after the target year?

The fund keeps running. Depending on its glide path, it either holds its final mix or continues shifting toward bonds for several more years. Many providers eventually merge it into a retirement income fund, and you keep the same balance.