Choosing a target-date fund

couple buying items online

So, you find the lazy way to invest very appealing: You like the simplicity and the long-term results. But you don't want to bother with building your own lazy portfolio of index funds and adjusting it as you get older (same as creating your own target-date fund). At this point in your life, you just want a set-it-and-forget-it solution, at least until you feel more comfortable building your own investment portfolio. Target-date funds seem perfect for the job, but which one is right for you? Let's walk through choosing a target date fund.

Related >> Investing 101: An Introduction to Index Funds and Passive Investing

Choosing the Fund Family

The first step is to choose the fund family (Fidelity, Vanguard, etc.). This decision cannot be overlooked since each company manages its funds differently; a 2040 target-date fund from T. Rowe Price will be different from a 2040 target-date fund at Fidelity. Each company has its own philosophy and methodology. Let's compare the three biggest players in this market: Fidelity Freedom Funds, T Rowe Price Retirement Funds, and Vanguard Target Retirement Funds.

Related >> a href=”https://www.getrichslowly.org/the-lazy-way-to-investment-success/”>The Passive Way to Investment Success

The first criteria you can use to compare the fund families is cost, specifically the expense ratio (the total annual cost for things like advertising and managing the fund). As an example, let's look at the 2040 funds:

Fund Family Expense Ratio
Fidelity 0.79%
T Rowe Price 0.79%
Vanguard 0.20%

Amazingly, Vanguard's expenses are roughly a quarter of the other two. This is largely due to the use of actively-managed mutual funds by Fidelity and T Rowe Price; Vanguard only uses low-cost index funds in their target-date funds. If you think 0.59% a year is a pretty small difference, remember that the rough rule-of-thumb for withdrawing money in retirement is only 4% a year. That “small” difference in expense ratios is almost 15% of your potential retirement income!

Another important criteria to consider is the asset allocation used by the target-date fund — how much is invested in stocks, and how much is invested in bonds and other instruments. In particular, you want to look at how that allocation is expected to change as you get older. Investing geeks like me call that the “glide path.”

Choosing Your Target Date

Once you select the fund family, you need to decide on the specific fund to buy. Target-date funds are labeled by retirement year, generally assumed to be when you turn 65. So the 2040 fund is designed for the “typical” person who's currently 35 and is expected to retire in 2040.

Obviously, no one is forcing you to buy the fund that corresponds to the year you turn 65. There are at least two very good reasons to adjust your target date:

  • If you plan on retiring much earlier or later than 65, you should consider adjusting your target date. Let's say you're 35 and want to retire at 55. Should you buy the target-date fund for 2030, since that's when you'd retire? Not necessarily. Although the 2030 fund fits your retirement plans, it also assumes people retire around age 65, so your life expectancy is probably much longer than the target audience for the fund. A good compromise might be the 2035 fund, which respects both your early retirement plans and your longer life expectancy relative to others you retire with.
  • Even if you expect to retire at 65, the amount of risk you want to take is probably not “typical”. An easy way to reduce risk is by selecting a fund with a target date that is five to ten years before when you turn 65. (So, if you plan to retire near 2040, you might choose a 2030 target-date fund.) This lowers the level of risk by holding less in stocks while still considering your investment horizon. And if you want more risk, you can select a target date that is five to ten years past when you turn 65. (If you plan to retire around 2030, you could increase risk by choosing a 2040 target-date fund.)

Even though they've received some bad press lately due to their poor performance during the recent stock market crash, target-date funds are still useful investments for many people. They're certainly better than other strategies commonly used by beginning investors: equal-weighting all funds within a 401(k) plan, picking stocks, or just leaving everything in a money market fund.

If you already use target-date funds, which funds do you own and how did you choose?

More about...Retirement, Investing

Become A Money Boss And Join 15,000 Others

Subscribe to the GRS Insider (FREE) and we’ll give you a copy of the Money Boss Manifesto (also FREE)

Yes! Sign up and get your free gift
Become A Money Boss And Join 15,000 Others
guest
35 Comments
Oldest
Newest Most Voted
Inline Feedbacks
View all comments
Pop
Pop
10 years ago

Nice post. I think one other thing to note might be that target date funds are designed to be the only fund you hold in your retirement portfolio. I’ve seen a ton of people hold a target date fund along with another equity index fund or bond fund. I guess that makes sense if they wanted to make their portfolios more conservative or aggressive, but I think sometimes it comes from a false sense that they need to “diversify” their funds when the funds themselves are already diversified.

Steve
Steve
10 years ago

Just picking a target 5 or 10 years closer or further may not make the difference suggested. Past a certain year (in the chart it’s 2040) the allocations for the various funds are all the same.

Nicole
Nicole
10 years ago

Thanks for this post. If I’d seen it a few months ago I wouldn’t have had to do quite so much research myself. I can get the Vanguard fund if I’m willing to pay a .7% fee (on top of Vanguard’s fee) to Ing to get it. I can get T. Rowe Price funds from a different provider (not T. Rowe Price though) at a slightly smaller additional cost. I can go directly through Fidelity and use their funds. I hate the way that my employer has something like 7-9 different providers, each of whom has somewhere between 10 and… Read more »

Sam
Sam
10 years ago

I’m not a big fan of target date funds, mostly because the cost is often much higher than other funds.

I think it is very important to know what you are buying into when you go with a target fund, there was a recent article on this topic that compared three very different target funds but with the same target date.

The idea that you can just stick all your retirement money into a target fund and forget it is wrong in my mind, but that is how these funds are sold.

Ely
Ely
10 years ago

I have a target date fund with T. Rowe Price and one with Vanguard. I love Vanguard’s low expense ratio, and TRP’s low buy-in price. When I decided to open a Roth IRA, TRP got my business because I only needed $50/month, instead of $1k-3k up front, to open it. I also have a regular IRA I opened when I was very young, which I’ve rolled my 401k’s into as I’ve changed jobs over the last 10-15 years. It was at UBS until they jacked up their annual fee, and then I moved it to Vanguard. I had enough to… Read more »

Alfonso
Alfonso
10 years ago

Hello,

I’m from Spain and I have been having a LOT of problems to get low cost target date funds. Fidelity has them but they charge 1.5% management fee. Do you know of any other that is sold in Spain? Or Europe?

Zeb
Zeb
10 years ago

Preach on about Target date funds! Sam mentioned that the cost is higher than other funds … partly true (compare Vanguard’s target fund to the total stock market fund and there’s ~.1% difference) but generally not accurate when comparing with the majority of other index funds. Vanguard’s annual expense ratio (that __% cost per year) is low for all their funds relative to other investment agencies as made clear above. Sam, you’re off the mark in criticizing those who “stick all [their] retirement money into a target fund and forget” … rather, those who elect to invest in higher cost… Read more »

Paul Williams
Paul Williams
10 years ago

I just wanted to say this post is a great guide to picking a target date fund despite the few comments it’s received so far. Vanguard is the best option for this based on my research (if you can buy directly from them). @Steve(#2): Picking a different year might not change your immediate allocation, but it will change how quickly you glide to the safer allocation. That will make quite a difference in your overall risk level for the long haul. @Sam(#4): I’m not sure which target date funds you’re referring to that have a higher overall cost than other… Read more »

Anna
Anna
10 years ago

I use T. Rowe Price Retirement 2055. (I’m 21.) I like it because I’m a fan of Ramit’s 85% solution… it’s more than adequate and everything happens automatically: my contributions, reinvestment of dividends, rebalancing. I’m lazy but I still want to save for retirement, and target date funds are for people like me! If you are really disciplined and you know 100% you will take the time to complete the task, then selecting your own balance of index funds could be good for you. But like I said, I’m lazy but still want to save. And like J.D. says, the… Read more »

Seymour
Seymour
10 years ago

Do you think it is reasonable to use a target fund to try to play catch-up? I am 46 and have not saved much for retirement. was living the bachelor life and being an idiot with my finances. I suddenly found myself married with 2 kids and now need to make up for lost time. I have a decent 401-k that has all the vanguard target funds available. My target retirement date should be 2030 but i feel like i need to be more aggressive than what that might provide. is a target fund with a later date a good… Read more »

Derrick
Derrick
10 years ago

Great post! Morningstar rated the T. Rowe Price and Vanguard (as well as American Funds and American Century) the top Target Date Fund Series. A synopsis is found here: http://www.smartmoney.com/investing/mutual-funds/target-date-funds-get-new-grades/ @Nicole(#3) I’m not sure what your particular situation is, but if you want to invest in a T. Rowe Price or Vanguard Target Date Fund, the best way to do it is directly with them (ideally in an IRA). If you have an IRA with ING, you can roll it over to either of them. @Sam(#4) While some Target Date Funds may charge more than the average of their underlying… Read more »

Torr
Torr
10 years ago

@Seymour (10): A later date target fund will probably contain higher fraction in equities and thus is likely to be riskier. Trying to catch up by taking more risk may not work since your retirement is now very strongly determined by what the market returns. This is something that you cannot control. There are 3 things that determine how much you end up with in retirement — 1) Savings rate, 2) Investment expenses, and 3) Asset allocation. You can possibly control 1) and 2) while 3) is influenced by market returns. One useful website that I tend to visit regarding… Read more »

Nicole
Nicole
10 years ago

@11 My IRAs are separate and happily invested in VFINX and QQQQ without Ing and their insane fee. As you know, you can only invest 5K/year in an IRA, which is not enough to fund a comfortable retirement.

The problem is the choices available through the employer for the 401(k)/403(b). There are a huge number of not very good options.

Torr
Torr
10 years ago

@13 Is yours a 403b? If so, do you have TIAA-CREF as a choice?

manish
manish
10 years ago

I’m in Canada (and we have better privacy laws and provisions here than you do in the US!). Here it’s called a SIN number, but it’s the same idea. Anyway, I only give it to three kinds of entities:
– government
– employers
– creditors (unfortunately, those include phone companies!)

No one else has a right to the number, and they rarely ask! 2

Carter Adler
Carter Adler
10 years ago

Personally, I think target-date retirement funds can be a great solution for most people.

Picking any investment and then forgetting about it is never a good solution, but the fact is that it happens a lot. (Probably less common for readers of this site than for the population at large.) If you accept that there’s always a possibility that you will forget about things like rebalancing, and a smaller possibility that you may even forget about an entire account (believe me, it does happen), you will probably be much better having that money in a target-date fund.

Luke
Luke
10 years ago

@ #15 – wrong comments section?

Janette
Janette
10 years ago

I really dislike sales pitches- unexpected here….

J.D. Roth
J.D. Roth
10 years ago

@Janette (#18)
I’ve been trying to figure out where you see a sales pitch, and I’m coming up puzzled. Can you point it out to me?

Evan H.
Evan H.
10 years ago

JD, I think Janette sees the focus on three specific funds from Fidelity, T. Rowe Price, and Vanguard as a sale pitch to invest through one of these companies.

I don’t see it this way. These are three of the most credible investment companies we have and is a great representative sample.

Nicole
Nicole
10 years ago

@14 Yes. Their target date funds are crazily conservative though. Their literature is also kind of hard to figure out so I haven’t thoroughly looked into their other options yet. Why do you ask?

@20… Also they’re the three most likely to show up in your employer plan. And yes, I’d like to see the comparison with TIAA-CREF too.

Edwin Choi
Edwin Choi
10 years ago

@Janette(18), Evan(20), Nicole(21) I chose those 3 fund families (Vanguard, Fidelity, T Rowe Price) because they were the 3 largest funds according to Morningstar, so it was an easy way to cover most investors. The analysis in the post can easily be extended to other funds (ING, TIAA-CREF, etc) by looking up their glide paths and expense ratios on their website. If I have time later today, I can post an updated chart. @Anna(#9), Carter(#16) I couldn’t have said it any better. I remember the day I started helping my in-laws with their investments. It took a long time to… Read more »

lane
lane
10 years ago

I think these funds are a good idea in general. I am very vigilant with my retirement and non-retirement investments. I rebalance on a regular basis and at age 55, my DH and I have substantial savings. We have ALWAYS maxed out retirement contributions, even in our 30’s with kids/mortgage. So I was disappointed in the performance of the portion I decided to put in the 2010 fund of one of the above companies in 2007. I tranferred less than 10% of total retirement assets into this fund and have still come up short as of this week, despite the… Read more »

Tyler
Tyler
10 years ago

Vanguard 2045 Fund for my ROTH accounts.

Stephen
Stephen
10 years ago

Funny this topic should come up. I just switched my 401k investments to a target date fund. Work uses Lincoln for their 401k so I’m limited to Wilshire’s offerings, however. So far the 2040 profile is working out well.

Edwin Choi
Edwin Choi
10 years ago

@Seymour(10): Your highest priority should be to start saving today. Although starting in your 40s is not ideal, it sure beats starting in your 50s or 60s. Looking at the chart above, the 2030 funds all have around 80% in stocks, although that drops over the coming years. This is far more aggressive than the rule-of-thumb of investing your age (as a %) in bonds. Your decision to take even more risk than a 2030 fund is really a personal one that depends on how much risk you are comfortable with, how much you can afford to start saving, and… Read more »

Nicole
Nicole
10 years ago

@26 Thanks! I’m going to have to look at TIAA-Cref again because that doesn’t look as crazy conservative as I’d thought. I wonder if I just got it wrong or if there was a typo in the literature I had. If its fees are reasonable it might be the right option… that would eliminate a lot of hassle. Any ideas what the fees are? This one confused me because it has two sets listed: Gross Expense Ratio : 1.45% Net Expense Ratio 1 : 0.72% Which number is the one I should be comparing to Fidelity’s .79%? ETA: Wikianswers tells… Read more »

Edwin Choi
Edwin Choi
10 years ago

@Nicole(27):
Yes, you should look at the net ratio. Here’s the updated list of expense ratios for 2040 funds as of 7/8/2010 on Morningstar:

Fidelity Freedom 2040 (FFFFX) 0.81%
T. Rowe Price Retirement 2040 (TRRDX) 0.79%
Vanguard Target Retirement 2040 (VFORX) 0.20%
Principal LifeTime 2040 Instl (PTDIX) 0.82%
TIAA-CREF Lifecycle 2040 Retire (TCLOX) 0.72%

Note that expense ratios even for the same fund family may differ by target-date.

Glad you found the post useful. Don’t be shy with follow-up questions!

Nicole
Nicole
10 years ago

Thanks again! And, hey, if you’re answering free questions… Our mandatory plan is an “optional retirement plan” 403(b) and we can contribute up to 6% of our salary to it with 100% match. After that we have the option of the following, up to the federal limit: Any thoughts on: 1. Tax-Deferred Account Program (TDA) – A voluntary program in which you may make pre-tax or after-tax (Roth) contributions. This is a defined contribution plan under Internal Revenue Code 403(b) which you decide how to utilize your account balance upon retirement. vs. 2. Deferred Compensation Plan (DCP) — A voluntary… Read more »

Edwin Choi
Edwin Choi
10 years ago

@Nicole(29):
Choosing between those plans is beyond what anyone can cover in a blog comment. Your HR dept should be able to answer any questions very easily.

I believe the limits are separate (link below), but make sure to confirm with your employer. I’m impressed that you are even considering saving more than the $16,500 limit!

http://www.prudential.com/media/managed/2010Limits_Govt-Bulletin-1009.pdf

Your employer matches up to 6%…that’s awesome. Hopefully, they also offer low-cost index and target-date funds.

Torr
Torr
10 years ago

@ Nicole (29):

My understanding is that you can actually contribute to both the 403b and the 457 as well and each up to its limit 16.5K for a total of 33K. However, please check with your HR/Benefits department.

http://www.457bwise.com/faqs/index.html

http://www.403bwise.com/wisemoves/403band457.html

I am impressed as well that you can save for both. Congratulations!

Unfortunately, I don’t have access to a 457 plan 🙁 I (and DW) contribute to the max to 403b and a Roth.

Nicole
Nicole
10 years ago

Well, I’m not sure we can save for both… we will see. I think we can either save for both OR prepay the mortgage but not all three. We do need to do some catch up retirement saving for various reasons and no longer qualify for IRA Roths (though I did do the Roth conversion this year). DH and I just did a bunch of reading and calling (which we were planning on doing in August, but hey, I didn’t want to get any work done today anyhow). We’re going to max out our mandatory optional plan (not that we… Read more »

Torr
Torr
10 years ago

My retirement plan only provides access to TIAA-CREF products. I just use the CREF Stock Fund which is primarily large cap. Technically, it is not a pure index fund. However, I like the diversification it gives — at present 70% domestic and 30% international. Furthermore it contains a tiny bit of Emerging markets as well. The costs are a little higher than the pure index fund with an expense ratio of 0.44%.

Bernake
Bernake
9 years ago

I like these funds because they prevent me from speculating on individual stocks and trying to time the market. Both these things should easily pay for the management fee in the long run.

Kim Tran
Kim Tran
6 years ago

Any advice– should I roll over my 401k to IRA w/ vanguard TR fund 2030? Since the fund has lowest ER compare to Trow or fidelity?

shares