FINANCIAL FRESHMAN #028

TL;DR → Target Date Funds, or TDFs, are common to see as available investment options within employer-sponsored retirement plans. These types of funds are goal-oriented, diversified, and automatic in that they transition stock holdings to less-volatile bond holdings as you approach retirement.

Target Date Funds (TDFs)

Recently on Financial Freshman, we’ve written quite a bit about 401(k) plans. We had a more introductory post covering the mechanics of a 401(k) plan itself, and then we published an FAQ that highlighted some of the lesser-known details. At this point however, we haven’t discussed in detail one of the most common investment options within 401(k) plans today—the target date fund.

Target date funds, or TDFs, were created by Donald Luskin and Larry Tint at Wells Fargo Investment Advisors in the early 1990s. Fast forward to today, and TDFs house $3.5 trillion dollars of wealth according to Morningstar, and account for 68% of all new 401(k) contributions according to the Employee Benefit Research Institute.

Target date funds are popular, and if your first employer offers a 401(k), there is a good chance you will encounter them. This raises some important questions. Should you invest in a target date fund if given the opportunity? How can you identify one among the options in your 401(k) plan? Lastly, and most importantly, what exactly does a target date fund do?

Mechanics of TDFs

To easily understand how a TDF works, you really just need to remember 3 adjectives: Goal-oriented, diversified, and automatic.

• Goal-Oriented: Every target-date fund has an associated target retirement year. This year serves as the fund’s goalpost, guiding how its investments are managed over time.
• Diversified: Target-date funds are broadly diversified across various asset classes, such as stocks and bonds. This diversification helps manage volatility and provides a balanced approach to long-term investing.
• Automatic: As you approach the target retirement year, the fund will automatically adjust its investments accordingly. It gradually switches from wealth building to wealth preservation, reducing exposure to the volatility of stocks in favor of the relative stability of bonds.

To visualize this automatic adjustment, consider this below graphic of a hypothetical TDF with a target retirement year of 2065. These values are random just to paint a picture, but note the changing ratios of stocks and bonds over time. When the target retirement year approaches, this fund also takes on a percentage in cash. Your specific TDF will follow a glide path, which governs what these real ratios will be.

Target Date Fund Examples

Now that you know how a TDF works in principle, let’s make sure that you know how to identify one when you see it! That way, when you start working full time and set up your 401(k), you can set up contributions into a TDF if you would like.

Below we’ve highlighted three target date fund examples, and provided some supplemental information for each one.

From this list of just three TDFs, we can see that the glide path will vary across different funds, but they share the commonality of increasing the bond % as the target year approaches. Seeing that target year within the fund name is oftentimes the easiest way to spot a TDF from a list of available funds.

Keep in mind as well that TDFs may be available outside of your specific servicer’s investment offerings. For example, inside of a 401(k) serviced by Merril, you may be able to invest in Vanguard TDFs.

Final Thoughts

We’ve covered what a target date fund does and how to identify one in your 401(k) plan, but whether you should invest in one is ultimately up to you. Your decision should be based on your individual financial goals, risk tolerance, and retirement plans. TDFs can be a convenient option for many, but it’s important to evaluate how they fit into your overall investment strategy.

When you start working full time and enroll in your 401(k), be on the lookout for available TDFs within your plan!