Should You Invest in Target Date Funds? Pros and Cons

Should You Invest in Target Date Funds? Pros and Cons

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Should You Invest in Target Date Funds? Pros and Cons 1

My company made Vanguard Target Retirement Funds available for our 401(k) accounts about two years ago. I have been evaluating these options, however, I have not moved my money into one of these funds yet because I prefer to manage my own asset allocation using the more traditional asset class-based  funds. However, I think Target Date Fund is an excellent option for 401(k) plans in general because it is a less intimidating way to present investment options to participants and will probably encourage a higher investment rate overall.

What are Target Date Funds?

A target date fund, or target retirement fund, is a mutual fund designed with a specific retirement year in mind. For example, if you are 20 years from retirement, and this is 2019, you’d pick a fund with a target year of 2019 + 20 = 2039. Since they are usually offered in 5 years increment, a 2040 Target Retirement Fund is the option you’d consider.

As the fund approaches the target retirement year, the fund asset allocation becomes more conservative — investing in more fixed-income investments — to decrease risks and preserve capital.

Here’s Vanguard 2010 versus 2040 (data as of Dec 2008 when this was originally written). This comparison illustrates how the fund changes over time:

Vanguard Target Retirement 2010 (VTENX)


Vanguard Target Retirement 2040 (VFORX)


Roughly speaking, Vanguard 2010 is more conservative with a 45% allocation to bonds versus only 10% bonds for Vanguard 2040. As time progress, Vanguard 2040 will slowly increase its bonds position.

Target Date Funds Advantages (Pros)

Personally, I think there are two things that make Target Retirement Funds attractive.

1. Easy to Understand and Start

This is one of those buy it and forget it investments. You just have to figure out when you want to retire and buy the fund with the closest retirement date. As you invest more money into your 401(k), you’ll automatically add to your position without having to worry about asset allocation and regularly rebalancing your portfolio. This is perfect for people who are afraid to get started with investing.

2. Instant Diversification

Target retirement funds help you automatically diversify between the two most important asset classes — equity and fixed-income. Additionally, Target Retirement Funds are what The Street calls “Funds of Funds“. This means they invest in other mutual funds, making them a very diversified investment.

For example, Vanguard 2040 is comprised of the following funds (data as of Dec 2008):

Fund Allocation Expense Ratio
Vanguard Total Stk Market Idx Fd Inc 72.08% 0.15%
Vanguard Total Bond Market Index 10.11% 0.19%
Vanguard European Stock Index 9.74% 0.22%
Vanguard Pacific Stock Index 4.37% 0.22%
Vanguard Emerging Mkts Stock Idx 3.66% 0.37%

3. Less Expensive for Businesses

This benefit might not be obvious to individual investors, but as a business owner, I had the opportunity to set up a Solo 401(k) account with Vanguard. One of the things I have to decide on was what investments I would like to have available in the plan. The only problem was that it would cost $20 per year for each Vanguard fund held in the 401(k) account. To save money on administrative fees, I opted to have only one fund…you guessed it…a Target Retirement Fund. (updated 2019)

Target Date Funds Disadvantages (Cons)

There are also a few things that make Target Retirement Funds unattractive:

1. Double Fee Structure

Target Retirement Funds are Funds of Funds. For some funds, you are paying for both the fund’s direct expense, and indirectly for all of the underlying funds’ expenses as well.

Note: Vanguard is an exception to this rule. The 0.21% expense ratio is the total expense you pay.

2. Skewing

Because the fund is designed to be optimally allocated for your target retirement date, you could potentially skew your portfolio if you own a Target Retirement Fund and also buy other mutual funds to “enhance” the portfolio. For example, if you have more equity investments in addition to a Target Retirement Fund, your overall portfolio is more aggressive. On the other hand owning fixed-income investments would do the opposite to your portfolio, skewing it the conservative side.

3. Hard To Evaluate

Because of the two layers structure, they are harder to evaluate than a traditional fund. Secondly, it’s hard to compare them to an index like the S&P 500 because they are diversified, including both equity and fixed-income investments.

4. Same Date, Different Allocation

You might have a false sense of security that just because the fund is targeted for a certain date that you’re getting the most optimized for that retirement date. Here is an excellent example using two of the most popular target date funds:

  • Vanguard Target Retirement 2040 Fund’s Objective: Seeks to provide capital appreciation and current income consistent with its current asset allocation. The funds provide broad diversification while incrementally decreasing exposure to stocks and increasing exposure to bonds as each fund’s target retirement date approaches. The funds continue to adjust for approximately seven years after that date until their allocations match that of the Target Retirement Income Fund.
  • Fidelity Freedom® 2040 Fund’s Objective – Seeks high total return until its target retirement date. Thereafter, the fund’s objective will be to seek high current income and, as a secondary objective, capital appreciation.

So they both have fairly similar objective, now let’s see what an optimized asset allocation for 2040 looks like (data as of July 2019):

US Stocks 49.80% 66.46%
International Stocks 33.40% 31.48%
Bonds 16.80% 8.06%

That’s a huge difference!

In summary, it is hard to compare Target Retirement Funds from different companies like Vanguard and Fidelity without spending time digging into each fund. In other words, a 2040 fund from one company could be very different from a 2040 fund from another.

5. One Size Fits All

Although it’s nice to be able to simply pick out the closest retirement date, these funds do not take your individual financial goals or risk tolerance level into account. That said, you can usually find ways to personalize your portfolio a bit.

If you have higher risk tolerance or need to invest more aggressively to reach your goals, you can buy a higher-dated fund (such as a 2050 fund if you want to retire in 2040) to increase your “expected” return. Another option is to add more traditional investments in the area(s) that you want to increase your exposure to.

Other Considerations When Buying Target Retirement Funds

There are also a few other things you may want to consider when investing in Target Retirement Funds.

1. Your Existing Portfolio

As mentioned before, owning other investments in addition to a Target Retirement Fund can actually work against you due to skewing. This means that if you want to get into a Target Retirement Fund you may have to consider liquidating your existing portfolio. At the very least, be very careful with its asset allocation. Portfolio liquidation can be a problem for investors who have accumulated a large amount of assets. Trading costs and potential tax consequences (especially for investments in taxable accounts) can erode returns and cause financial strain.

2. Actively Managed Fund

Some Target Retirement Funds are actively managed, and there’s the potential that your fund manager may stray from the stated investment policy. For example, he or she may be investing more aggressively than stated in order to outperform other Target Retirement Funds. This is especially worrisome for investors who are near their retirements.

Note: this is not the case with Vanguard Target Retirement Funds, which are made up of index funds.

Bottom Line

Personally, I remain undecided about whether or not I should leverage a Target Retirement Fund in my 401(k) account. I enjoy managing my own portfolio, and there are some disadvantages to consider. However, I think Target Retirement Funds are good for people who don’t want to bother managing the portfolio on their own. A target date fund is far better than neglecting the portfolio altogether.

What are your thoughts on Target Retirement Funds? Do you invest in them? What do you like or dislike about them?

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Matt TurnerDanPeter LetiziaKevin Mulligantom vecchio Recent comment authors
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Jeff Rose

You are right to stay away. Target date funds are one of the biggest ripoffs in the industry. Sure, they make it easy for the uneducated investor, but at what price. I’ve seen target date funds with expense ratios over 2%. Top that with minimal performance and you have the epitome of a “lemon”. Great article. Hope many readers find it.

Phil Taylor

I’m currently investing in a TRF: Schwab Plan Retirement Trust 2040. Have been for about a year now. Expense ratio is .54 of fund assets. But I don’t see any “funds within funds” expense. Can someone please show me what that is? And how come I never see these expenses on my statement?

Investing education is a hurdle I’ll admit that I need to get over, but it’s frustrating when you can’t see things clearly, b/c investment firms make it difficult.

Mr. GoTo

Another reason not to use target date retirement funds is if you do not subscribe to the theory that the best asset allocation strategy requires a gradual transition from equities to bonds and cash purely as a function of age. I for one do not think that is the best strategy to provide a stable standard of living in the pre- and post-retirement phases.


Great job on this! More and more people are investing in these in their 401(k) because they are easy. Although this may not be the best move, at least they are not leaving it in the default money market account. I also like the fact that many 401(k)s are making these target-date funds the new default fund. It will help out individuals who would otherwise leave their money in the money market account due to lack of education. Which is something else companies have to work on: educating their employees.


With Vanguard, your 0.21% expense ratio is all you pay.

Another reason that Vanguard is simply the best investment company out there.

Plus gradually shifting from stocks to bonds without having to do much portfolio tweaking is an attractive option to many (myself included).

Also, at least with Vanguard, you get a little bit of instant diversification when you first start (stocks/int’l stocks/bonds in the mix).


Another good reason to use Target Retirement Funds is that you need a substantial portfolio value to properly allocate and diversify. The minimum to get into a Vanguard TRF is $3000. But the minimum to buy into all of those funds separately is $15,000 — and that just gives you equal ownership in those 5 funds. You’d need $82,000 to assemble the same portfolio outside of the TRF.

So TRFs are a great way to get started as an investor, and once a large enough portfolio is built, one can start to customize.


The below seems to indicate Vanguard doesn’t double-charge. “Although the Fund is not expected to incur any net expenses directly, the Fund’s shareholders indirectly bear the expenses of the underlying Vanguard funds (the Acquired Funds) in which the Fund invests. These expenses, along with the transaction costs (i.e., purchase and redemption fees), if any, imposed on the Fund by the Acquired Funds, are reflected below in the line item for “Acquired Fund Fees and Expenses.” However, they also indicated with fine print under “Annual Fund Operating Expenses” “the Total Annual Fund Operating Expenses shown in this table do not correlate… Read more »

Mark LaPointe
Mark LaPointe

It appears that Fidelity matches the practice referenced above at Vanguard. Look at its prospectus for the Fidelity Freedom 2030 retirement fund (or any of the others). They charge no management nor 12b-1 fees, but do pass through the expense ratio of the underlying funds. Further, http://www.investopedia.com/terms/a/acquiredfundfeesandexpenses.asp#axzz1d3sPznbV says it’s now a requirement to name the double-dipping fees if any: “What Does Acquired Fund Fees And Expenses – AFFE Mean? A line item in a fund-of-funds’ prospectus that shows the operating expenses of the underlying funds. This became a requirement as of January 2007 and this information is found beneath the… Read more »

Dave Smith
Dave Smith

I currently manage my own portfolio using the same funds as the Target Ret. Funds, but am considering switching to the Target Ret. 2020 for our IRAs for one reason: my wife is not as financially savy as I am, and if I die before she does, this would make things a whole lot easier for her. I would not use TR20 in our taxable account, however, as I prefer to use munis for the bond portion here. Only one thing I don’t like about The TR Funds: they’re a little light on mid/small caps. I currently hold a percentage… Read more »

tom vecchio
tom vecchio

I have been considering the Asset Management service at Vanguard because I am 87 and preparing for my eventual demise and transfer to my 67 year old wife, who is not very financially savvy.Suddenly, the idea of getting into their 2010 Retirement fund instead, without the 0.7% management fee, and similar diversification looks very appealing. Any comments?

Peter Letizia
Peter Letizia

I’m still trying to figure out where/how to invest after retirement. Does a target fund still work after the retirement date? I have less than two years to go.


I am retiring in a few months and am considering “bucket strategizing” within the Vanguard Target accounts. For example 30% in 2015, 30% in 2020 and 30% in 2025 etc and withdraw approx 4% from each for my living expenses. My thought would be that I would be covered for market ups and downs. Any thoughts/critcisms?

Matt Turner
Matt Turner

The use of “units” as value variables, really makes for some sneaky accounting and fee collection.
Anyone offering a Vanguard Target Retirement Fund is themselves making money off of selling it, and companies are pouring their employee’s retirement accounts into it without those employees knowing anything about it. Sign here, they say.

Should You Invest in Target Date Funds? Pros and Cons

by Pinyo time to read: 5 min