Target date funds: Letting time do its work

Juggling investment options can feel like another full-time job, especially if you have multiple mutual funds, stocks and bonds. One way to potentially simplify your choices is by exploring different fund categories, like target date mutual funds.

Target date funds, often found in 401(k) plans, are designed to adjust your portfolio’s risk as you get closer to retirement. Early on, they invest aggressively to aim for strong returns, then gradually shift to more conservative investments as retirement nears. This built-in rebalancing removes guesswork from managing risk over time.

By understanding how these funds work and their associated costs, you can decide if they align with your retirement goals.

A target date fund is named for the year its investors typically plan to retire and start withdrawing their money. You choose a fund with a date that aligns with your expected retirement year, and an investment manager or an algorithm determines the rest, adjusting the investment mix over time as you approach retirement.

The mix of assets in a target date retirement fund is built on diversification, the practice of spreading your money across a variety of assets to help shield your portfolio from losses in any one investment. With a target date fund, the manager takes care of selecting the mix of assets to invest in and the gradual transition of asset mixes over time—giving the investor the benefit of a sound risk management strategy with diversified assets.

A glide path is the strategy a target date fund uses to gradually change its mix of investments as you near your projected retirement date.

Early in your fund’s investment timeline, the glide path usually emphasizes stocks and other investments with greater growth potential. As the target retirement date approaches, it generally shifts toward bonds and other more conservative investments to reduce risk.

Think of a glide path as easing off the accelerator. Earlier on, the fund may take on more risk before “slowing down” and settling into a more conservative speed.

Glide paths vary by provider, so two target date funds with the same retirement year may have different investment mixes and risk levels. Some funds continue becoming more conservative after the target date (i.e., “through funds”), while others reach their most conservative allocation around retirement (i.e., “to funds”). In other words, different glide paths may ease off that accelerator at different rates and for different lengths of time.

Choosing a to fund versus a through fund is a personal decision, and neither is better than the other. If you choose a to fund, it will reach its most conservative investment mix around your target retirement date and generally stay there. If you choose a through fund, it will continue adjusting your investment mix even after the target date, typically becoming more conservative as you move further into retirement.

Which works best for you depends in part on how you plan to use your retirement savings, including when you expect to start taking withdrawals and how much investment risk you're comfortable with. Check whether your target date fund follows a “to” or “through” glide path and consider talking with an advisor about which approach fits your retirement plans.

If you're new to investing and learning the ins and outs of risk and dollar-cost averaging, target date funds can give you a diversified mix of investments in a single fund, without having to make large initial investments.

Even if you’re an experienced investor, you may not know when or how to rebalance your mix of stocks, bonds or mutual funds from riskier investments to more conservative ones in a way that aligns with your risk tolerance. A target date fund helps make those calls for you.

Plus, it can offset some of the impact of inflation on your money by generating returns while also reducing the impact of a market shock right before your retirement.

This hands-off approach is also why many 401(k) plans use target date funds as the automatic default if you don't choose an investment yourself. This is known as a qualified default investment alternative (QDIA).

If you choose a target date fund, you will be charged fees to cover the cost of managing the fund. Target date funds generally use a fund of funds structure, meaning your target date fund invests in other mutual funds or index funds. Because there can be costs associated with both the target date fund and the underlying funds it invests in, fees can stack across these different levels.

Expense ratios vary widely, but target date funds can generally range from less than 0.10% to around 1% or more, depending on how the fund is managed and what it invests in. Index-based target date funds tend to have lower fees, while actively managed funds generally cost more.

These fees can also affect your long-term returns, so it’s worth reviewing a fund’s expense ratio and investment approach before investing. If your target date fund is offered through a 401(k), also consider the plan’s other administrative or investment-related fees.

Although both are investment options, an index fund generally tracks one fixed market benchmark, such as a broad stock market index. Unlike a target date fund, its investment strategy doesn't automatically change as you approach retirement, so you decide when and how to adjust your portfolio as your goals change.

A target date fund takes a more hands-off approach. It typically holds a mix of mutual funds or other investments and automatically adjusts that combination over time, generally shifting toward more conservative investments closer to retirement.

If you want more control over how your investment mix changes with time, an index fund may be the right approach for you.  If you prefer an investment that automatically adjusts as retirement approaches, a target date fund might make more sense. Either way, consider your savings goals, risk tolerance, ideal investment timeline and any related fees.

While target date funds offer a number of benefits, they might not be a good fit for every investor. From accruing fees to varying risk profiles, there are a few potential drawbacks to keep in mind as you consider your options.

Target date funds often consist of other mutual funds. At each level, investment managers handle the activities of buying and selling stocks, bonds and other assets. That means there are fees and expenses for your portfolio at each level. As a result, all-in-one funds like target date funds can have higher costs than other mutual funds.

Another potential issue with selecting target date funds is that your retirement intentions can change over time. While you can transfer your money from one target date fund to another, your already-invested money will have been on a different risk trajectory, which may affect how your investments grow over time. This is something to consider if you think there's a possibility you might wish to retire earlier or later than planned.

One other consideration is that if you invest in target date funds as well as other investments, you may or may not be hitting your optimal risk level at any given time. The idea of simplified, all-in-one investing can be nice—but especially when it comes to coordinating a wide portfolio of investments, easy doesn't mean optimal. A financial advisor can help you look objectively at how target date funds, plus all your other investments, align with your overall risk tolerance and goals.

Funds with the same target year can have meaningfully different investment mixes depending on the provider. One fund may hold more stocks, while another may hold more bonds. So, don’t choose a fund based only on the year in its name.

Use these six steps to compare your options and to help choose a fund that fits your retirement plans.

1. Confirm your expected retirement year. Choose a target date that closely matches when you expect to retire.
2. Check whether it is “to” or “through.” See whether the fund reaches its most conservative investment mix at the target date or continues adjusting after it, and consider which approach better fits your plans for using the money in retirement.
3. Compare expense ratios. If you have more than one option, check each fund’s expense ratio. Lower fees can leave more of your money invested.
4. Check how it is managed. Find out if the fund uses index investing, active management or a combination of both, keeping in mind that the approach affects the fees.
5. Look at the investment mix. Funds with the same target year can have different amounts in stocks and bonds, so compare their investment mixes and risk levels rather than relying on the target year alone.
6. Consider how much of your portfolio it should cover. If you have questions about how much of your portfolio should be in a target date fund, talk with a financial advisor.

A target date fund can be a core part of your portfolio alongside other investments, depending on your investment timeline, risk tolerance and retirement goals. A Thrivent financial advisor can help you consider how it fits into your broader investment strategy, review its glide path and fees and determine whether a “to” or “through” approach better aligns with your retirement needs.