Target-Date Funds in 401(k): Are They Right for You?

Retirement planning can feel overwhelming, especially when facing a menu of mutual funds, stocks, and bonds in your 401(k) plan. That’s why target-date funds (TDFs) have become a go-to option for millions of Americans. These funds offer a “set it and forget it” approach, automatically adjusting your investment mix as you move closer to your retirement date. TDFs are now the default investment in many workplace retirement plans, and their popularity continues to grow.

Are target-date funds in 401(k) the right choice for you? Let’s break down how target-date funds work, their pros and cons, and how to decide if they fit your unique retirement goals.

Target-Date Funds in 401(k): How Do They Work?

The Glide Path Concept

When you invest in a TDF, you pick a fund that matches the year you expect to retire (for example, a “Target 2050 Fund” if you plan to retire around 2050). The fund manager then handles the rest, starting with a portfolio heavily weighted toward stocks and gradually shifting to more conservative investments like bonds as your retirement date approaches.

This gradual change in asset allocation is called the “glide path.” Early on, the fund seeks growth by investing in riskier assets. As you near retirement, it prioritizes preserving your savings by reducing stock exposure and increasing bonds and cash equivalents. TDFs rebalance automatically, so you don’t have to worry about adjusting your portfolio each year. Some funds, known as “through” funds, continue to get more conservative even after your target date, while “to” funds freeze the allocation at the target date.

Selecting a Target Date

Choosing a target-date fund is simple: select the fund with the year closest to when you plan to retire. If you’re aiming to retire in 2050, you’d pick a 2050 fund. But what if your plans change? You can always switch to a different fund if you decide to retire earlier or later.

It’s important to note that the “target date” is just a guideline. The fund doesn’t automatically cash out or become ultra-conservative on that date. Instead, it continues to manage your portfolio for the years you’ll spend in retirement, gradually reducing risk.

Pros of Target-Date Funds in 401(k)

Simplicity and Convenience

One of the biggest draws of TDFs is their simplicity. Instead of juggling multiple funds and rebalancing every year, you get a diversified, professionally managed portfolio in a single package. This “all-in-one” approach is hard to beat for busy professionals or those new to investing.

Professional Management

With a TDF, you benefit from the expertise of professional fund managers who monitor the markets and adjust the fund’s allocation over time. This can help you avoid common investor mistakes, such as panic selling during market downturns or chasing hot stocks.

Automatic Adjustments

As you approach retirement, your TDF automatically shifts to a more conservative mix, reducing your exposure to market volatility at a critical time. This “autopilot” feature can give you peace of mind, knowing your investments are being managed with your timeline in mind.

Built-In Diversification

TDFs hold a mix of asset classes—stocks, bonds, and sometimes alternative investments—providing instant diversification. This helps spread risk and smooth out the market’s ups and downs.

Behavioral Benefits

Research shows that investors in TDFs are less likely to make emotional decisions during market swings. During the 2008 financial crisis, most 401(k) holders with TDFs stayed the course, while many do-it-yourself investors sold at the worst possible time. By automating rebalancing and allocation, TDFs can help you “stay the course” for the long haul.

Target-Date Funds in 401(k): Cons and Limitations

One-Size-Fits-All Approach

While TDFs offer convenience, they’re not tailored to your individual goals or risk tolerance. The fund manager decides the glide path and asset allocation, which may be too aggressive or too conservative for your preferences. If you have unique circumstances, such as significant savings outside your 401(k) or a higher (or lower) risk appetite, a TDF may not be the best fit.

Fee Structures

TDFs are typically “fund of funds,” meaning they invest in a collection of other mutual funds. This can result in higher fees than building your own portfolio of index funds. Expense ratios vary widely, from as low as 0.08% for some Vanguard funds to 0.75% or more for others. Over the decades, these fees can eat into your returns, so it’s important to compare costs.

Lack of Customization

With a TDF, you give up control over investment choices and allocation adjustments. A TDF may feel restrictive if you want to tilt your portfolio toward certain sectors, adjust your risk level, or make changes based on market conditions. You can always switch funds, but you can’t tweak the underlying mix.

Performance Variability

Not all TDFs are created equal. Different fund families have different glide paths, investment philosophies, and performance records. Some may be more aggressive or conservative than others, and returns can vary significantly. It’s important to review each fund’s strategy and track record.

Who Should Consider a Target-Date Fund?

Best-Fit Scenarios

TDFs are an excellent choice for:

• Investors Who Prefer a Hands-Off Approach: If you don’t want to spend time picking funds or rebalancing, a TDF offers a simple, effective solution.
• Those New to Investing: TDFs provide instant diversification and professional management, making them ideal for beginners.
• People With Most of Their Retirement Savings in a 401(k): If your 401(k) is your main retirement account, a TDF can provide a solid foundation.

When a Custom Strategy Might Be Better

A TDF may not be right if:

• You Have Unique Goals or Preferences: If you want to retire much earlier or later than the typical age, or if you have a higher or lower risk tolerance, you may want your own portfolio.
• You Have Significant Assets Outside Your 401(k): If you’re coordinating investments across multiple accounts, a custom strategy may offer better tax efficiency and risk management.
• You Want More Control: DIY investors who enjoy managing their own asset allocation may prefer to select individual funds.

How to Evaluate Target-Date Funds in 401(k)

Comparing Glide Paths and Fund Families

Not all TDFs follow the same glide path. Some funds are more aggressive, keeping a higher percentage in stocks until the target date, while others shift to bonds sooner. Review the fund’s prospectus or fact sheet to see how the allocation changes over time.

• “To” Vs. “Through” Funds: Decide if you want a fund that freezes its allocation at retirement (“to”) or continues to get more conservative after retirement (“through”).
• Fund Family Reputation: Look for established fund families with a track record of managing TDFs through different market cycles.

Reviewing Performance and Fees

• Historical Returns: Compare how the fund has performed against relevant benchmarks and similar TDFs. Remember, past performance isn’t a guarantee of future results, but it can show how the fund has handled market volatility.
• Expense Ratios: Lower fees mean more of your money stays invested. Compare the expense ratios of different TDFs in your plan.
• Underlying Investments: Check what funds the TDF invests in. Are they low-cost index funds or higher-fee actively managed funds?

How Beem Can Help You Decide on Target-Date Funds

Beem is a digital financial tool designed to help you make smarter retirement decisions:

• Budget Planner: Visualize your retirement timeline and see how different target dates affect your investment growth.
• Fund Comparison Tools: Easily compare TDFs in your plan, reviewing glide paths, fees, and historical performance.
• Educational Resources: Access guides and articles on risk, diversification, and retirement planning, so you can make informed choices.
• Reminders and Reviews: Set alerts to review your fund selection, increase contributions, or adjust your strategy as your goals evolve.

With Beem, you can confidently decide whether a target-date fund fits your needs-or if a more customized approach is right for you.

Conclusion

Target-date funds offer a powerful blend of simplicity, professional management, and automatic adjustments, making them a wise choice for many 401(k) investors. They’re especially valuable for those who want a hands-off approach or are just starting. However, they’re not perfect for everyone. A custom strategy may be better if you crave more control, have unique goals, or want to fine-tune your asset allocation.

Understand how TDFs work, compare your options, and regularly review your plan as your life and goals evolve. For any financial aid, you can check out Beem. It is a smart wallet app with numerous features, from cash advances to help with budgeting and even tax calculations. In addition, Beem’s Everdraft™ lets you withdraw up to $1,000 instantly and with no checks. Download the app here.

FAQs for Target-Date Funds in 401(k) Plans