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Target-Date Funds: The Good and Bad

Since their creation in the mid-1990s, target date funds (TDFs) have grown to become one of the largest segments of the fund space in the investment world. At the end of 2021, their total assets reached over $3 trillion. While they have several good things going for them, they also have their share of 'quirks' as well. In this post, I'll review both.

The Good

After some laws were changed in the year 2006, TDFs could potentially be used as an employer's 'qualified default investment alternative' (QDIA). As of now, approximately 58% of all money going into defined-contribution plans, such as 401(k) plans, goes into TDFs. Given this, the market appears to like TDFs quite a lot. Below are some reasons why.


TDFs are part of the broader category of funds sometimes referred to as 'all-in-one' funds. This means that, at a minimum, they hold both stocks and bonds at all times. Part of a TDF's name includes a year, ideally the year that participants in the fund will retire and begin making withdrawals from the fund. TDFs whose 'date' is decades into the future are heavily weighted toward stocks, but this allocation is gradually reduced over time until approximately ten years after the fund's 'date'. TDFs were created to be a 'set it and forget it' investment vehicle that those not savvy about investing could both easily understand and stick with.

Encourage Good Behavior

Generally speaking, investors have a habit of buying when the markets are doing well and selling when the markets are doing poorly (i.e., 'buy high and sell low'). But TDFs help investors to avoid this bad behavior, likely for two reasons. First, the 'date' in TDFs helps investors remember that they are investing for the long haul and that short-term downturns are par for the course. Second, the fact that the various holdings of TDFs are all lumped together and investors only directly see the overall performance of the fund helps them to avoid selling assets that are temporarily 'beaten up' but are likely to have higher returns in the future.

Consequently, investors in TDFs tend to have meaningfully higher returns than investors in other funds.

Built-in Diversification

TDFs hold hundreds and usually thousands of securities, which basically eliminates what is known as idiosyncratic risk (i.e., the risk of a single security doing poorly). There is far more to portfolio diversification than reducing idiosyncratic risk, but many investors can and often do a lot worse in terms of diversification than take what TDFs offer.

Automatic Gliding and Rebalancing

In keeping with a traditional view that investors should invest aggressively when they are younger and then progressively invest more conservatively as they age, TDFs are all designed to do precisely this. And they also rebalance their holdings daily to maintain their target asset allocation, which also helps to avoid poor investor behavior, such as failing to rebalance or 'buying high and selling low', as described above.

Angel's Landing, Zion National Park

The Bad

For all the good aspects of TDFs, they have a number of potential drawbacks, some of which may be rather serious to some investors.

Not 'Best' for Anyone

The Department of Labor specifies that, in order to be a QDIA, a TDF cannot take into account the investment goals of any one individual but must instead reflect the collective goals of an employer's entire workforce. They are designed to be a 'one-size-fits-all' investment, which means that a TDF's investment approach is likely not the 'best' in any real meaning of the word for any individual worker.

Likely Inappropriate Asset Allocation

From a mathematically driven perspective, there is no objective need for an investor who won't be retiring for 20 years or more to hold any fixed income, such as bonds, whatsoever. Any allocation to fixed income over stocks is very likely to be nothing more than a drag on returns. Granted, most TDFs whose 'date' is far into the future hold 90-95% of their assets in stocks, but that 5-10% that is held in bonds is only there because the Department of Labor essentially requires it.

More broadly speaking, an acknowledged problem of TDFs is that virtually all of them hold too much fixed income (i.e., bonds and cash), making them overly conservative in their growth potential. For instance, Vanguard's 2025 TDF currently holds 55% in stocks, and their 2020 TDF holds only 43% in stocks. Most TDFs eventually drop their stock allocation to only 20-40%. This is a level that has only been historically appropriate for very conservative investors. And in many contexts, such a low stock allocation may significantly increase retirees' total risk. For instance, the so-called '4% rule' has worked best for stock allocations in the 50-70% range. Virtually no TDFs maintain a stock allocation in that range throughout an investor's retirement. Further, such a low stock allocation, especially when combined with such a high allocation to nominal bonds rather than TIPS (more on that below), exposes retirees to significant risk from unexpected inflation.

However, even though TDFs tend to be too conservatively allocated, research has found that younger investors with TDFs as the default investment option in their workplace retirement plan still have higher allocations to stocks than other investors. So, TDFs may help to get investors closer to where they likely need to be, even if they don't get them all the way there.

Also, it's possible that a very conservative investor might find a TDF's asset allocation to be too aggressive for their tastes. For instance, I've personally known at least one individual of significant financial means who never wanted to hold any stocks at all.

Little or No TIPS Holdings

Treasury-inflation Protected Securities (TIPS) are, in my view, more appropriate for the lion's share of individual investors than are nominal bonds, but TDFs usually include no TIPS in their holdings at all or, at best, only a relatively small quantity of their total fixed income holdings.

High Expense Ratios

TDFs are rather notorious for having high expense ratios, which in this context are nothing more than a drag on returns. Morningstar found that TDFs in 2021 had an average expense ratio of .34%. Thankfully, TDF expense ratios have been dropping over time, but it is still possible for investors to hold identical assets to those in TDFs and pay total expenses of around .05%, about seven times lower than that of the average TDF. Note that fund providers like Vanguard, Fidelity, Schwab, and TIAA have TDFs with expense ratios well below the industry average, though not all TDFs offered by even these providers have low expense ratios.

Tax Inefficient

Because all their holdings are in a single fund, TDFs are not very tax efficient. This isn't a problem for those holding TDFs in tax-advantaged accounts like 401(k) plans and IRAs, but it's a real problem for investors with holdings in taxable accounts. For instance, over the last 10 years, the pre-tax return of Vanguard's 2025 TDF (VTTVX) was 5.96%, but the post-tax return at the highest marginal rates and no sales of shares was 4.73%. That was substantial tax drag that could have been largely avoided by placing the stocks in a taxable account and the fixed income in a tax-advantaged account, for instance. Note that stock index funds usually have very little turnover, resulting in most of their tax drag coming from dividends.

No Tilting

Many investors like to deviate from a 'pure' market-capitalization driven asset allocation and weight more heavily in certain types of investments (e.g., factors in stocks, corporate or high-yield bonds, real estate), a practice referred to as 'tilting', but this is not possible with a TDF. Broadly speaking, providers of TDFs are strongly incentivized by the legal system to be as 'plain vanilla' as possible and tend to rely heavily on index funds. Any deviation from a 'total market' approach in a TDF is likely to generate lawsuits and more if/when such an investment approach lags the broad market's performance. Note that some TDFs use actively managed funds rather than index funds, but this invariably results in higher expense ratios.

Holdings May be Offensive to Christians

Christian investors who are concerned about holding objectionable companies may want to steer clear of TDFs, as most of their stock holdings are in large companies that often engage in unbiblical activities, as noted here.

Final Thoughts

Despite their flaws, there's little room to dispute that TDFs are a far better choice for workplace retirement plans than something like cash or a cash equivalent. And there's not much room to argue that, on average, investors have higher returns with TDFs than do other investors. But they are less appropriate when (1) the investor wants a significantly different asset allocation than the TDF, (2) the TDF is held in a taxable account, (3) the TDF's expense ratio is high, (4) the investor wants a larger allocation to TIPS than the TDF provides, or (5) the investor finds the TDF's holdings to be morally problematic.

Some have suggested that some of the flaws of TDFs can be at least partially resolved by combining a TDF with other funds. For instance, Paul Merriman, who has long advocated for investors to tilt toward small-cap value stocks, believes that combining a TDF with a small-cap value fund can be helpful by increasing the investor's allocation to stocks and providing more exposure to factors.

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