Target Date Funds: Are They Too Conservative?

Target date funds are the default investment choice for millions of Americans saving in employer-sponsored 401(k) plans. They offer a hands-off approach to investing. You pick the year you plan to retire, and the fund managers handle the rest. However, as retirement approaches, many investors are starting to ask a critical question. Do these funds play it too safe? Reevaluating your retirement timeline and understanding how these funds work is crucial to ensuring your portfolio actually fits your long-term financial goals.

Understanding the Glide Path

To understand why a target date fund might be too conservative, you first need to understand its mechanics. Every target date fund operates on a “glide path.” This is the formula the fund uses to shift your money from riskier assets like stocks into safer assets like bonds and cash as you get older.

When you are 30 years away from retirement, your fund will be heavily invested in stocks. For example, the Vanguard Target Retirement 2055 Fund is designed for younger workers. It holds roughly 90% in stocks and 10% in bonds. At this stage, the fund is aggressive because you have decades to recover from stock market downturns.

As the target year gets closer, the glide path dictates that the fund automatically sells stocks and buys bonds. By the time you reach your target retirement year, the asset allocation is entirely different.

The Problem with Playing It Too Safe

The central debate among financial planners is whether this automatic shift to bonds happens too quickly or goes too far. For many retirees, a target date fund may become too conservative right when they actually need their money to continue growing.

There are two massive risks associated with a portfolio that is too heavy in fixed-income assets:

• Longevity Risk: Modern medicine and healthier lifestyles mean that a retirement starting at age 65 could easily last 25 to 30 years. If your money stops growing at age 65, you risk running out of funds by age 85.
• Inflation Risk: Even if the stock market crashes, inflation is a guaranteed force that constantly erodes your purchasing power. If inflation averages 3% a year, the cost of living will double in 24 years. Bonds generally offer lower returns than stocks, making it harder for a bond-heavy portfolio to outpace inflation over three decades.

Consider the Vanguard Target Retirement 2025 Fund. Just one year out from its target date, the fund holds roughly 54% of its assets in stocks and 46% in bonds. Seven years after the target date, it merges into the Vanguard Target Retirement Income Fund, which holds a static allocation of about 30% stocks and 70% bonds. For a healthy 72-year-old facing another two decades of living expenses, a 30% stock allocation might not generate enough growth to sustain their lifestyle.

"To" Versus "Through" Retirement Funds

Not all target date funds follow the exact same rulebook. When evaluating your own fund, you need to find out if it is managed “to” retirement or “through” retirement.

A “to” target date fund arrives at its most conservative asset allocation in the exact year of the target date. Once you hit that year, the asset mix locks into place.

A “through” target date fund assumes you will leave your money invested well into your retirement years. These funds reach their most conservative point 10 to 15 years after the target date. Brokerages like Fidelity and Vanguard typically use “through” glide paths for their primary target date series. Even so, the final stock allocation in these funds still drops heavily, which prompts investors to seek alternatives.

How to Reevaluate Your Strategy

If you look at your target date fund and feel the bond allocation is too high for your specific goals, you have several straightforward ways to adjust your strategy.

Pick a Later Target Date

You do not have to pick the fund that matches your exact 65th birthday. If you plan to retire in 2030 but want a more aggressive stock allocation, you can simply invest in a 2040 or 2045 target date fund. By choosing a date further in the future, you trick the fund into keeping your money in stocks for a longer period.

Build a Hybrid Portfolio

You do not have to put 100% of your money into a single target date fund. Many investors use a target date fund for their core retirement savings but supplement it with a low-cost stock index fund. For example, you could put 70% of your contributions into a Charles Schwab Target 2030 Index Fund and direct the remaining 30% into a Charles Schwab S&P 500 Index fund. This instantly increases your overall stock exposure while keeping the process relatively simple.

Consider Outside Income Sources

Your risk tolerance should be based on your entire financial picture. If you have a guaranteed pension plan, rental property income, or plan to wait until age 70 to claim a maximum Social Security benefit, your baseline income is highly secure. Because your basic living expenses are covered by guaranteed money, you can afford to take more risk with your 401(k) or IRA. In this scenario, dumping a conservative target date fund for a broad stock market index fund might make perfect sense.

Frequently Asked Questions

What happens to a target date fund when it reaches the target year?

The fund does not close or liquidate. It simply reaches a very conservative mix of stocks and bonds. Depending on the fund manager, it will either lock into that specific asset allocation forever, or it will continue to slowly decrease its stock holdings for a few more years before locking into a final, highly conservative “income” allocation.

Can I lose money in a target date fund?

Yes. Target date funds are invested in the open stock and bond markets. They are not guaranteed by the FDIC or the government. If the stock market drops sharply, the value of your target date fund will drop as well.

Are target date funds expensive?

It depends on the provider. Index-based target date funds from companies like Vanguard, Fidelity, and Charles Schwab are generally very cheap, often charging expense ratios below 0.15%. However, some actively managed target date funds charge high fees (sometimes over 0.60%) which can eat into your retirement growth over time. You should always check the expense ratio of the fund offered in your 401(k).