What Is a Target-Date Fund (TDF)? Risk Tolerance and Example

What Is a Target-Date Fund (TDF)?

A target-date fund or TDF, to investors, is a long-term investment account that is automatically adjusted over the years as the investor approaches a specific milestone such as retirement.

TDFs are designed to invest heavily in riskier growth stocks in the early years. This is intended to rack up gains while the investor has plenty of time to recover from any short-term losses. In later years, the investment choices lean towards more conservative choices to consolidate gains and avoid untimely losses.

Target-date mutual funds are offered by many company 401(k) plans. TDFs also are an option for people investing in individual retirement accounts (IRAs).

How a Target-Date Fund (TDF) Works

Target date funds use a traditional portfolio management method to revise asset allocation over the term of the fund to meet the investor's objective.

A fund's portfolio managers use this predetermined time horizon to fashion their investment strategy according to a standard long-term asset allocation strategy. This strategy relies on riskier stocks in the early years, moving gradually toward fixed-income investments like bonds in later years.

The fund managers use the target date to determine the degree of risk currently appropriate for the investor. Target-date portfolio managers typically readjust portfolio risk levels annually.

These increasingly popular funds generally include the target date in the fund name. For example, the Vanguard Target Retirement 2070 Fund (VSVNX) is designed to reach the investor's objective in 2070.

Risk Tolerance Over Time

Following its initial launch, a target-date fund has a high tolerance for risk and therefore is more heavily weighted toward high-performing but speculative assets. At the annual adjustment, portfolio managers will reset the allocation of investment categories.

A target-date fund’s portfolio mix of assets and degree of risk becomes more conservative as it approaches its objective target date. Higher-risk portfolio investments typically include domestic and global equities. Lower-risk portions of a target-date portfolio typically include fixed-income investments such as bonds and cash equivalents.

Most fund marketing materials show the allocation glide path—that is, the shift in asset allocation—across the entire investment time horizon. The funds structure their glide rate to achieve the most conservative allocation right at the specified target date.

Some target-date funds, known as “through” funds, will also manage funds to a specified asset allocation past the target date. In the years beyond the target date, allocations are more heavily weighted toward low-risk, fixed-income investments.

Other target-date funds, known as "to funds," cease any modifications to asset allocation once the target date is reached.

Advantages and Disadvantages of TDFs

Advantages

Target-date funds are popular with 401(k) plan investors, particularly those who don't have the time or the inclination to review their fund's holdings annually and revise their investment strategy appropriately.

TDFs allow investors to put the work on autopilot. A younger worker hoping to retire in 2065 would choose a target-date 2065 fund, while an older worker hoping to retire in 2030 would choose a target-date 2030 fund.

For some, TDFs eliminate the need to add another retirement savings vehicle as a backup to a 401(k). Some financial professionals advise that if you invest in only one long-term savings plan, it should be a TDF.

Disadvantages

The autopilot nature of target-date funds can cut both ways. The predetermined shifting of the portfolio assets may not suit an individual's changing goals and needs.

What if you have to retire substantially earlier than the target date, or decide you want to keep working longer?

In fact, there are no guarantees that the fund will generate a certain amount of income or gains. A target-date fund is an investment, not an annuity. As with all investments, these funds are subject to risk and underperformance.

Special Considerations

Check the Fees

Target-date funds can be expensive. A TDF is a fund of funds (FoF), meaning it is a mutual fund that invests in other mutual funds or exchange-traded funds. That means you have to pay the expense ratios of those underlying assets as well as the fees of the target-date fund.

An increasing number of TDFs are no-load funds and, overall, fees have been decreasing. Still, it is something to watch out for, especially if your fund invests in a lot of passively managed vehicles. Why pay double fees on index funds when you could buy and hold them on your own?

Compare Funds

Also, it's worth bearing in mind that similarly named target-date funds are not the same—or, more specifically, their assets are not the same.

Yes, all 2045 target-date funds will be heavily weighted toward equities, but some might opt for domestic stocks while others look to international stocks. Some might go for investment-grade bonds and others choose high-yield, lower-grade debt instruments.

Make sure the fund's portfolio of assets fits your comfort level and own appetite for risk.

Example of TDFs

Vanguard is one of the investment companies offering a comprehensive series of target-date funds. Below we compare the characteristics of the Vanguard 2065 (VLXVX) fund to the characteristics of the Vanguard 2025 fund (VTTVX).

The Vanguard Target Retirement 2065 Fund (VLXVX) has an expense ratio of 0.08%. As of May 31, 2024, the portfolio allocation was 89.49% in stocks, 9.61% in bonds, and 0.90% in short-term reserves. It holds other Vanguard mutual funds to achieve its goals.

It had 54% invested in the Vanguard Total Stock Market Index Fund, 36.30% invested in the Vanguard Total International Stock Index Fund, 6.70% invested in the Vanguard Total Bond Market II Index Fund, and 3% invested in the Vanguard Total International Bond II Index Fund.

The Vanguard Target Retirement 2025 Fund (VTTVX) has an expense ratio of 0.08%. Because it matures much sooner than the 2065 fund, it is more conservative. As of May 31, 2024, its portfolio is weighted 52.02% in stocks, 47.08% in bonds, and 0.90% in short-term reserves.

It has allocated 31.50% of assets to the Vanguard Total Stock Market Index Fund, 28.80% to the Vanguard Total Bond Market II Index Fund, 21.10% to the Vanguard Total International Stock Index Fund, 12.40% to the Vanguard Total International Bond II Index Fund, and 6.20% to the Vanguard Short-Term Inflation-Protected Securities Index Fund.

Both funds invest in almost all the same assets; however, the 2065 Fund is more heavily weighted toward stocks, with a relatively smaller percentage of bonds and cash equivalents. The 2025 Fund has greater weight in fixed income and fewer stocks, so it is less volatile and more likely to contain the assets the investor needs to begin making withdrawals in 2025.

The Bottom Line

Target-date funds are set up to coincide with an investor's retirement timing. The funds start off with more aggressive investment choices in their early years. As the target date approaches, the choices get more conservative to preserve gains.

Target-date funds can be a great investment option for those not interested in constantly reconsidering and adjusting their investment choices.

Target-date funds can be relatively expensive in terms of fees. They also differ greatly from company to company. Check the prospectus before you make a decision.