Target-date funds: how they work
How target-date funds shift from stocks toward bonds over time, what a glide path is, why funds with the same year can differ, and what to check before using one.
By 401k Resources Editorial Team · · 4 min read
Key points
- A target-date fund holds a mix of investments that typically becomes more conservative as a stated year approaches.
- The schedule for that shift is called the glide path, and it may run to the target date or continue through it.
- Funds with the same target year can hold different mixes, follow different glide paths and charge different fees.
- A target-date fund does not guarantee income or protect against losses, including at or after the target date.
On this page
A target-date fund is a single fund that holds a mix of stocks, bonds and other investments and changes that mix over time. The year in the fund's name is the target date, usually the year an investor expects to retire. These funds, also called lifecycle funds, are a common option in workplace retirement plans, and a plan may place contributions in one when an employee is enrolled automatically.
What a target-date fund does
According to the SEC's investor bulletin on target-date funds, these funds are designed to make investing for retirement more convenient in two ways: by spreading money among different investments, and by changing the investment mix as time passes.
The investor picks a fund by its year. The fund's managers then make the decisions about asset allocation, diversification and rebalancing. For background on those ideas, see asset allocation and rebalancing and diversification explained.
The reasoning behind the shift is about time. A person with many years before retirement has more time to recover from market declines than a person about to begin withdrawals. So the fund typically starts out weighted toward stocks and moves toward bonds as the target year nears.
How the fund is built
A target-date fund is typically a "fund of funds." It does not usually buy individual stocks and bonds. It buys shares of other funds, each covering a different asset class, and adjusts how much it holds of each.
Many target-date funds are mutual funds or exchange-traded funds registered with the SEC. Some target-date funds in workplace plans are structured as collective investment trusts, which are overseen by banking regulators and are not registered with the SEC. The investing approach can be similar, but the disclosure documents differ.
The glide path
The schedule on which the fund shifts its mix is called the glide path. The SEC describes two types.
| "To" glide path | "Through" glide path | |
|---|---|---|
| When the shifting stops | At or around the target date | Some years after the target date |
| Mix at the target date | Typically at its most conservative | Typically still becoming more conservative |
| General tendency | Moves to conservative investments earlier | Is in higher-risk investments at many points along the way |
Neither type is better in general. A "through" fund is generally built on the idea that the investor may stay in the fund after the target date. A "to" fund reaches its final mix at the target date. Which one fits depends on a person's comfort with risk and overall finances.
Why two funds with the same year can differ
The year in the name says little about what is inside. The SEC bulletin points out that funds with the same target date often have:
- Different investment mixes. One fund may hold considerably more in stocks at the target date than another.
- Different glide paths. The timing and pace of the shift vary.
- Different fees. Costs vary from fund to fund.
Fees
Because a target-date fund usually invests in other funds, costs can exist at two levels: the target-date fund itself and the underlying funds it owns. The SEC notes that the fee table in the fund's prospectus shows both. The underlying funds' costs appear on a line called "Acquired Fund Fees and Expenses."
The total annual operating expense figure is a common basis for comparing funds on cost. Fund fees and expense ratios explains how to read the fee table.
What a target-date fund does not do
- It does not guarantee anything. The SEC states that target-date funds structured as mutual funds and ETFs do not guarantee sufficient retirement income or any specific level of income. The fund can lose value at any point, including in the target year and after it.
- It does not know the investor. The fund is built around one fact, a year. It does not account for a pension, a spouse's savings, other accounts, health or planned retirement spending.
- It does not convert savings into income. Reaching the target date does not trigger payments. Decisions about withdrawals remain with the investor. See turning savings into retirement income.
Common misunderstandings
"The fund becomes all cash at the target date." Not necessarily. A fund may still hold stocks at the target date, and "through" funds keep adjusting afterward.
"The year must match my retirement year." The year is a starting point. The SEC notes that someone planning to retire in a given year may decide, based on risk tolerance and other assets, that a fund with an earlier or later date is a better fit.
"Holding a target-date fund alongside other funds adds diversification." It may instead change the overall mix in ways the investor did not intend. A target-date fund is designed as a complete allocation. Combining it with other stock or bond funds shifts the total away from the fund's glide path, so it helps to look at the combined result.
Automatic enrollment
Employers are permitted to enroll employees in a retirement plan automatically and to invest their contributions in a target-date fund within the plan. The SEC suggests that anyone enrolled this way look at information about the fund they were placed in, since a fund with another target date, or another type of fund in the plan, may make more sense for their situation.
Questions worth asking
- How much does the fund hold in stocks today, at the target date, and at its most conservative point?
- Is the glide path "to" or "through," and when does it reach its final mix?
- What is the total annual operating expense, including the underlying funds?
- What other savings and income sources exist, and how does this fund fit with them?
This article is general education, not investment, tax or legal advice.
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