Target-date funds (TDFs) have rapidly gained traction in the realm of retirement savings, becoming the favored choice for many investors within 401(k) plans. As of 2023, approximately 29% of assets in the average 401(k) plan are allocated to TDFs. This figure is expected to spike, with projections indicating that by 2027, TDFs could capture around two-thirds of all contributions to 401(k) plans. While TDFs present a simplified approach to investing for retirement, they also come with certain limitations that potential investors should consider.
TDFs serve as a one-stop solution for retirement savers. They automate critical decisions about asset allocation and investment selection, effectively removing these responsibilities from the hands of individual investors. This characteristic particularly appeals to those who prefer a hands-off approach to retirement planning. According to Christine Benz, a financial expert, “From where I sit, target-date funds have been nothing short of the biggest positive development for investors since the index fund.”
The growing popularity of TDFs can be attributed to their default status in many company 401(k) plans. Workers who are automatically enrolled often find themselves invested in these funds, which are designed to adjust over time. The asset allocation within TDFs gradually becomes more conservative as the target retirement date approaches. For instance, a 35-year-old planning to retire in 30 years would typically select a fund targeting the year 2055. Conversely, a 55-year-old nearing retirement might opt for a fund aimed for 2035. These funds usually come in five-year increments, catering to various investor timelines.
Current trends suggest that TDFs are likely to capture about 66% of all 401(k) contributions by 2027. Additionally, around 46% of total 401(k) assets could be held in TDFs by that same year. This significant shift indicates a growing reliance on TDFs among retirement savers.
Despite their advantages, experts caution that TDFs may not be suitable for every investor. Winnie Sun, a financial advisor, notes, “Target funds have a place for some investors, but they certainly aren't and shouldn't be used for everyone.” Since employers typically offer TDFs from a single financial company, there is a risk that the chosen fund may not align with an investor's specific risk profile or financial goals.
One limitation of TDFs is their inability to facilitate “tax location,” which refers to the strategic placement of assets across different tax-advantaged accounts. For example, high-growth investments are generally more beneficial when placed in Roth accounts due to the tax-free nature of earnings in retirement. As it stands, many investors may miss out on optimizing their tax strategy by relying solely on TDFs.
The convenience and simplicity of TDFs attract those who prefer an easier approach to managing their investments. Sun emphasizes this point: “They’re designed to be easier-to-manage investments for those who just prefer simplicity and more convenience.” However, this simplicity can come at a cost if investors do not fully understand the underlying structure or performance of the funds they are invested in.
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