Investing Basics: What Is a Target-Date Fund? 

More common in the US where they are a staple of the 401k account, target-date funds are now becoming more common in the UK. Christian Leeming explains what they are and how you may use them when planning for retirement. 

Target-date funds – also called TDFs – enable groups of pension savers that are all targeting a similar retirement date to save together in a single investment fund. The mix of assets within the fund changes over time to reflect the needs of scheme members as they approach – and go beyond – their target retirement date. 

Target-date funds are typically mutual funds, designed to grow assets in a way that is optimized for a specific time frame. The funds address an investor’s capital needs at some future date— the ‘target date’ – with its portfolio allocation becoming increasingly conservative over time. 

Most often, investors use target-date funds to save for their retirement, but they can equally be used for other key financial goals such as tuition fees, or property purchase. 

The funds periodically adjust the weighting of the asset classes they hold to optimize risk and returns for a predetermined time frame; they offer investors the convenience of putting their investing activities on autopilot in one vehicle. 

Target-date funds usually mature in 5-year intervals, such as 2045, 2050, and 2055; although relatively more expensive than some other types of mutual fund, fees on target-date funds have reduced in recent years. 

How a Target-Date Fund Works 

Funds are named by the year the investor plans to use the assets, and are typically used as very long-term investments; eg in July 2017, Vanguard launched its Target Retirement 2065 products – a time horizon of 48 years. Target-date funds use traditional portfolio management over the term of the fund to meet the investment return objective.  

A fund’s portfolio managers use the predetermined time horizon to decide their investment strategy, based on traditional asset allocation models, and determine the degree of risk the fund is willing to undertake, which is adjusted each year. 

Initially, a target-date fund has a high tolerance for risk and is more heavily weighted toward high-performing but speculative assets such as equities. A fund’s portfolio becomes more conservative as it approaches its objective target date, moving into lower risk investments such as fixed-income bonds and cash equivalents. 

Each target-date fund has its own factsheet showing the allocation glide path across the entire investment time horizon; they achieve the most conservative allocation at the specified target date. 

Some also manage funds to a specified asset allocation past the target date, usually more heavily weighted toward low-risk, fixed-income investments. 

Advantages of Target-Date Funds 

Target-date funds are popular with investors in the US saving for their retirement with 401(k) plans; instead of creating a portfolio to help them reach their retirement goals, investors choose a single fund to match their planned retirement date. 

A target-date fund is the ultimate set-it and forget-it investment and may be the only investment in an investor’s retirement fund. The asset allocation is automatically risk-adjusted over time, with the one constant being the end date. 

Disadvantages of Target-Date Funds  

The automated nature of the glide path to retirement may also be considered a disadvantage as it cannot reflect an individual’s changing circumstances, goals and needs.  

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

Also, as every risk warning will tell you, there is no guarantee that the fund will generate a certain amount of income or indeed any gains at all. A target-date fund is an investment, not an annuity, and as with all investments, they are subject to risk and underperformance and a fund’s earnings may not beat inflation over the duration. 

Because a target-date fund is technically a fund of funds (FoF)—a fund that invests in other mutual funds or exchange-traded funds— you have to pay the expense ratios of those underlying assets, as well as the fees of the target-date fund, so they may be relatively more expensive than other collective investments. 

Where a fund is heavily invested in passive investments – usually ETFs – it would be possible for an investor to buy and hold these investments directly, thereby avoiding double fees, although that is to forsake the simplicity and low maintenance of target-date funds. 

When considering a target-date fund it is worth looking under the bonnet as funds with the same target date may differ in terms of the assets they hold; true, all 2050 target-date funds will be heavily weighted toward equities, but some might opt for domestic stocks, while others look to international stocks.  

Some might favour investment-grade bonds, others high-yield, lower-grade debt instruments, always, ensure a fund’s portfolio fits your comfort level and appetite for risk. 

Vanguard is an investment manager offering a comprehensive series of target-date funds; here we compare the characteristics of the Vanguard Target Retirement 2065 fund to the characteristics of the Vanguard 2025 fund. 

The Vanguard Target Retirement 2065 Fund has an ongoing charge (OCF) of 0.24%. As of Q2 2022, the portfolio allocation was 80% in stocks and 20% in bonds. It holds other Vanguard mutual funds to achieve its goals.  

It had 19% in the Vanguard U.S. Equity Index Fund GBP Acc, 18.9% in Vanguard FTSE Developed World ex-U.K. Equity Index Fund GBP Acc and 15.5% in Vanguard FTSE U.K. All Share Index Unit Trust GBP Acc 

The Vanguard Target Retirement 2025 Fund also has an OCF of 0.24%. Because it 
matures 20 years in advance of the 2065 fund, it is more conservative, with 56% in equities and 44% in bonds. 

It has allocated 19.2% to the Vanguard Global Bond Index Fund GBP Hedged Acc, 18.8% to Vanguard FTSE Developed World ex-U.K. Equity Index Fund GBP Acc and 11.4% to Vanguard Global Aggregate Bond UCITS ETF GBP Hedged Accumulating 

Both funds invest in the same assets, but 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. 

It is possible to continue to continue to hold a fund after the target date, although it may behave differently depending on the type fund you have. A ‘through fund’ will continue adjusting its asset allocation toward more conservative holdings as time passes; a ‘to-fund’ will retain its final asset allocation as of its maturation date indefinitely. 

In general, a target-date fund will have somewhat higher charges compared to a standard mutual fund. because even if it is an index target-date fund, it is a fund-of-funds that invests in other mutual funds, and is more actively managed to ensure regular rebalancing. 

Most target-date funds are established in 5-year intervals (e.g. maturing in 2030, 2035, 2040 etc) and there is no set rule if your birth year doesn’t end with a 5 or a 0 – you can round up to the 2035 fund, or if you have a lower risk tolerance, use the nearer-term 2030 one. You could also choose to put something like 60% of your allocation in 2035 fund and 40% in the 2030 fund. 

Because many such funds are relatively recent inventions in the UK it may not be possible to assess their performance over a long time-horizon.