For investors who want a “set it and forget it” retirement
account, target-date funds have been the go-to solution.
An estimated 40 million Americans have put at least part of
their retirement money in target-date funds since they first started hitting
the market in the early ’90s. The amount of money in target-date mutual funds
and exchange-traded funds—whose mix of stocks and bonds go from riskier to more
conservative over time—has now reached $1.746 trillion. If you have a 401(k) or
other retirement account that invests in the market, chances are that some of
your money is in a target-date fund.
But many investors are in the dark about target-date
funds—how they work, how much they cost, whether there are risks.
At the same time, some members of Congress have questioned
whether these funds are worth it for investors. In May, members of the House
Committee on Education and Labor as well as the Senate Committee on Health,
Education, Labor and Pensions requested that the Government Accountability
Office investigate target-date funds.
What is in these funds, and why are they being scrutinized?
Here’s what you need to know.
How do the funds work?
Typically, target-date funds include a mix of stock funds
and bond funds. These can be either actively managed mutual funds or index
funds (and there are also target funds in the form of collective investment
trusts—low-cost investment vehicles that use strategies similar to mutual
funds). The exact mix of stocks and bonds is partly based on an investor’s age
when they enter the fund and partly on when the investor plans to retire.
Target-date funds create what is called a “glide path” based on this
Generally speaking, the glide path is designed so that the
portfolio is growth-oriented during an individual’s prime earning years and
then shifts to a focus on capital preservation the closer someone gets to
retirement—the “target” year. (That target year will usually be part of the
fund’s name. A fund with 2022 in its name, for example, is geared for someone
retiring next year.)
How much do they cost?
Prices vary considerably depending on the provider and
customizations. Vanguard Target Retirement 2050 Fund (VFIFX), which relies on
Vanguard’s low-cost index funds, has an annual expense ratio of 0.15% of
assets. At the other end, Fidelity Freedom 2050 Fund (FFFHX), which uses
Fidelity’s active-management approach, has an expense ratio of 0.75%. The bulk
of target-date funds land somewhere in between, with the average expense ratio
being 0.55%, according to Morningstar.
Costs have come down within target-date funds as providers
shift from mutual funds into lower-cost vehicles, including collective
investment trusts and index funds. But it is still important to understand the
total cost of the investment so that it doesn’t significantly erode your
portfolio returns over time. If your 401(k) includes a custom target fund—which
includes alternative asset classes such as real estate—the fees could be higher
than a fund from a low-cost provider.
What kind of performance can I expect?
It depends. Target-date-fund providers were investigated
after the 2008-09 financial crisis because many of the funds posted significant
losses owing to highly concentrated equities positions—even though fund
providers touted the offerings as low risk. Since then, target-date-fund
providers have taken steps to make sure that there is better risk management in
place. The funds were tested last year during the pandemic, but they fared
well. Funds that reached the end of their glide path in 2020 ended the year up
10.8% on average, according to data from Morningstar.
What happens when I retire?
Target-date funds are designed to deliver you to your
desired retirement age, but once you get there, what to do next is up to you.
Many investors are opting to leave assets in the target-date
fund beyond the target age because it can be easier than trying to change. The
assets generally stay in whatever mix of investments was in place when the fund
reached the target date.
If you decide to roll over the fund from a 401(k) or IRA to
a Roth IRA or an annuity—two of the most common choices—you may need to pay up.
There are conversion costs associated with both options. Annuity conversion
fees, for example, can range from 2% to 4% of the total value of the portfolio.
Depending on the type of IRA investors pick, they could have
a significant tax bill at the point of conversion, based on a number of
factors. A financial adviser can help with the decision.
Are there downsides?
Remember, target-date funds have high expense ratios. So,
over the life of the fund, you’re eroding the size of your total portfolio
faster than you would with a cheaper investment.
Then, when it comes time to sell, you’re likely going to get
hit with even more costs. If you sell into an up market, you will face
capital-gains tax, assuming you’re not in a tax-advantaged plan like a 401(k)
or IRA. Plus, putting the money someplace else—such as a Roth IRA—will come
with a price tag and probably additional taxes. The impact of all that could be
relatively minor if you’ve saved enough; if you haven’t, it could be a major
And, remember, all of that assumes you’re selling into an up
market. A down market, combined with higher fund expenses, could amount to a
bigger bite out of a portfolio than investors anticipate.
Why are these funds being scrutinized now?
The Government Accountability Office has agreed to look into
the funds and determine whether an update to guidance released in 2011 on how
to choose the right target-date fund is appropriate. The GAO is investigating
the variation among target-date funds in terms of the mix of stocks and bonds,
fees and performance. Congress has questioned whether the variation makes it
too difficult for average investors to compare funds and understand what they
Congress also specifically asked the GAO to focus on whether
target-date funds are too heavily weighted toward equities near retirement,
which could make them riskier than many investors anticipate.
Additionally, the GAO will be looking into a recent Labor
Department rule change that would make it easier to include alternative
investments like private equity in target-date funds, which could lead to
Could new asset classes be added?
Last summer, the Labor Department confirmed that plan
sponsors could consider target-date funds that include private equity without
running afoul of retirement rules designed to protect investors from risky and
expensive investments. That opened a door for investment managers to begin
including the asset class in retirement funds. However, to date there aren’t
any providers that have opted to do that in their off-the-shelf target-date
Congress has asked the GAO to look into the rule change as
part of its investigation into target-date funds, given the higher investment
fees associated with private equity. Adding private equity could also raise
some issues around transparency, as private funds don’t have the same
disclosure requirements as mutual funds or index funds. Providers that are
interested in adding private equity to target-date funds will likely wait for
the outcome of the GAO’s research before adding the asset class to funds.
Life-cycle funds: Another name for target-date funds.
Life-cycle funds are not to be confused with lifestyle funds, which generally
don’t change their asset allocations over time in a predetermined way.
Target-date or life-cycle funds, in contrast, are designed for people expecting
to retire in a particular year. That year is usually a part of the fund’s name.
Glide path: The asset-allocation path that the target-date
fund follows to become more conservative over time, as retirement approaches.
Qualified default investment alternative (QDIA): An
investment option in a retirement plan that an investor can be put into if he
or she doesn’t choose otherwise. Target-date funds qualify, as do balanced
funds and managed accounts.
Corrections & Amplifications
Life-cycle funds, also known as target-date funds,
automatically adjust their asset mix over time—designed for people expecting to
retire in a particular year. These funds are different from lifestyle funds,
which generally don’t change their asset allocations over time in a
predetermined way. The Glossary in an earlier version of this article
incorrectly used the lifestyle-fund definition for the life-cycle funds.
(Corrected on Sept. 8, 2021)
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