Target date funds: What are they and are they right for you?

 

Target date funds: What are they and are they right for you?

If you are in a 401(k) plan at work, you very likely have the option to invest in a so-called target date fund, which also may be called a retirement date fund or a lifecycle fund. At the end of 2020, the vast majority of plans (86%) offered target date funds, and 59% of 401(k) participants had money invested in one.

That’s according to an analysis by the Employee Benefit Research Institute, which reviewed anonymized data on 11.5 million 401(k) participant accounts from employers of all sizes. So what is a target date fund exactly? It’s a blend of stocks and bonds — an all-in-one portfolio — designed to offer an appropriate allocation for the average investor relative to their anticipated retirement date. 

In other words, you’d pick a fund that aims for a retirement year closest to the year you’ll turn 65. For example, if you’re 25, you might invest in a 2065 target date fund. If you’re 50, you would pick a 2040 fund. The high percentage of 401(k) participants with money in a target date fund is partly because it is often the default investment for employees who are automatically enrolled in a plan or whose plan changes hands after a merger.

How a target date fund invests

Typically a target date fund is a “fund of funds” – meaning its portfolio is made up of both stock funds and bond funds selected by the manager. Each target date fund has a future “glide path” for allocation, which is meant to grow more conservative over time. For instance, a fund aimed at a retirement date 40 years from now will be invested mostly in stocks (e.g., 90% stocks, 10% fixed income), whereas when the target date is just a few years away, the fund may allocate less than 50% to stocks – and by the actual retirement year, the stock allocation may be much less, said certified financial planner Madison Sharick of Madi Manages Money.