Target Date Funds: Wealth Accumulation Made Simple

Since their creation over three decades ago, target date funds have generally enhanced investment outcomes for retirement savers, particularly relative to many previous default 401(k) investment options. Gone are the days when money market funds, stable value funds, or even individual stocks served as the dominant default retirement investments. These investments largely produced inferior retirement outcomes relative to the modern diversified target date fund and didn't consider how risk tolerance changes over time. That's why it's no surprise that target date funds have become the most popular investment choice in 401(k) plans nationwide.

• Simplify investing
• Manage risk
• Help savers stay invested
• Lower volatility
• Designed for long-term holding
• Offer low-cost professional management 
   

Complex investment products often grab headlines, but many carry higher costs and have limited performance history. While they may play a role in an investor's non-retirement portfolio, their purpose within a retirement vehicle remains uncertain. Instead, it is often the approach with a proven track record—much like a reliable and affordable car from a trusted brand—that will efficiently and simply get investors from A to B. The majority of the population doesn't need a fancy sports car or an elaborate retirement strategy; they need something they can depend on. Target date funds can play that role, allowing investors to earn, save, and live while the fund handles the rest.

A core differentiator of target date funds is that they consider investor behavior and market risks when allocating assets as investors age. For those far off from retirement, these funds typically hold high equity exposure. This can help younger investors—who can handle more risk and have time to recover from market downturns—maximize long-term wealth accumulation. On the flipside, as investors approach their retirement date, target date funds shift toward more conservative, income-producing investments to protect savings and minimize the impact of market corrections.

In other words, target date fund allocations evolve as the investor evolves, considering both market dynamics and investor propensity to either take on too much risk or stay overly conservative at the wrong points in their investment journey. This automatic shift toward more conservative investments over time is called the "glide path," and it can help investors build and then protect their capital over the long term.

Target date funds also address one of the biggest dilemmas for retirement investors: asset allocation. Constantly weighing how much money to allocate to equity, fixed income, or other asset classes can be challenging, and many retirement savers simply don't have the knowledge or experience required to make these decisions. With target date funds, asset allocation decisions are made by experienced, professional asset managers whose objective is simple: accumulate enough assets to fund the typical investors' retirement needs.

"The beauty of target date funds is their ability to evolve with the investor and minimize behavioral biases that can completely derail retirement portfolios," said Inga Rachwald, senior investment portfolio strategist at Schwab Asset Management.

Diversification is a core feature of target date funds. Rather than relying on any single asset class or market sector, these funds spread investments across a broad mix of stocks and bonds. This can lower portfolio volatility and potentially help reduce the damage of market downturns, which is critical for retirees who are counting on steady income from their portfolios. Ultimately, retirement investing is less about guessing which strategy will outperform in any given year and more about maintaining a disciplined approach that can hold up over the long term. Diversified target date funds are built around this idea.

Fund costs directly impact investor returns, which is why it is no surprise that the lowest cost target date funds have pulled in the most assets in recent years. The good news for investors is that fees across the target date fund industry have significantly declined over the past two decades. Between 2008 and 2022, for example, the average expense ratio of target date funds dropped by 52%, according to the Investment Company Institute.

As a result, with a target date fund, not only can investors select an investment that evolves and reduces portfolio risk as they approach their retirement goals, but they can also control their costs. By investing in a lower cost target date fund, investors can save a substantial amount of money since fees, like returns, compound over time. Yet, what you get for that low cost is continuous portfolio management and oversight, a task that demands more time and attention than most investors can offer.

The primary goal of a target date fund is to provide income in retirement, which requires a thoughtful, long-term risk-managed asset allocation approach.

Instead of focusing on this goal, many investors simply compare target date fund performance to a broad market index, or whichever market sectors are performing the best at a particular point in time. This approach fails to consider investors' retirement goals and investment risks, which can subject investors to considerable losses, particularly in volatile markets.

"Investors often focus solely on outperforming index benchmarks or peers when the real question should be, 'Are we on track to attain sufficient savings for your critical retirement period?'," said Rachwald. "Achieving that goal means investing with stability in mind, particularly as you near retirement, and not overreaching with risky strategies in an attempt to juice returns. That's where target date funds come in and where they've been largely successful."

As investors transition into retirement, balancing withdrawals with portfolio stability becomes increasingly important. Since target date funds manage risk and lower portfolio volatility, they may help support more consistent income over time by reducing the odds of depleting assets too quickly.

The proliferation of target date funds in recent decades has resulted in meaningful accumulation of savings for millions of retirement investors. Through a fully managed, diversified, risk-aware, and behavioral-based asset allocation approach focused on time-tested core asset classes, investors can minimize the risks and behavioral biases that can derail their long-term goals, and instead focus on achieving durable savings through retirement. The resultant stable and liquid retirement income from target date funds can help to keep investors on track through volatile and unpredictable markets.