What to Do When a Target-Date Fund Just Doesn’t Cut It

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Both the appeal and drawbacks of target-date funds lie in their simplicity.


Target-date funds are the workhorses of America’s retirement plans—and for good reason. They offer a turnkey solution to a vexing problem: how to make saving for retirement a set-it-and-forget-it decision.

Yet while the funds have their benefits, they may not work well for every investor.

“Target-date funds solve for a lack of investor sophistication or lack of time,” says Daniel Yerger, a financial planner in Longmont, Colo. “But they don’t ask a lot of questions other than ‘How old are you?’ ”

There are times when it may make sense for certain investors to swap out that target-date fund for a more sophisticated approach.

Both the appeal and drawbacks of the funds lie in their simplicity. A target-date fund automatically rebalances its assets, gradually adjusting its allocation of stocks and bonds to become more conservative as the fund approaches its target date (typically the approximate year you expect to retire). Total assets in the funds reached a record $3.27 trillion in 2021, according to Morningstar. the most recent data available.

Yet a Bank of America research report last June found target-date funds’ returns wanting. A typical 2040 fund, which would likely be used by people who joined the workforce in 1995, had a similar risk profile to the S&P 500 but has trailed the index by 2.4% a year, according to the report. The below-average performance was due in part to the fund’s overinvesting in foreign stocks, the report said.

Of course, not all target-date funds are created equal. “They might all say 2045, but each will have a different allocation,” says Leanna Devinney, a branch leader at Fidelity Investments. “One may be active, another passive. The fees will also be different. So it’s important to look under the hood and understand what’s in there.”

What you find may not match your risk tolerance or goals.

Workers in their 50s or 60s who are behind on their retirement savings goals may want a more aggressive portfolio strategy. They would find target-date funds a poor fit because many funds begin shifting their asset allocation to a more conservative mix of stocks and bonds about 10 years before their target date. Right when the investor wants to shift into high gear, in other words, the target-date fund is going in the other direction.

To better tailor investments, consider replacing a target-date fund with a three-fund approach, says Andy Kapyrin, co-chief investment officer at CI RegentAtlantic Private Wealth in Morristown, N.J. “You may want one investment that tracks bonds, one investment that tracks U.S. stocks, and one that tracks stocks outside the U.S.,” he says. That would provide diversification and the ability to adjust the mix of stocks and bonds.

Risk-averse investors, meanwhile, may be uncomfortable with the typically heavy allocation to equities that target-date funds use in their early years. Last year’s market volatility, when the S&P 500 fell 19%, would have given them angina. The Vanguard Target Retirement 2055 fund (ticker: VFFVX), for example, has nearly 90% of its funds allocated to stocks and was down 17% in 2022. Over time, using a three-fund approach, investors could dial down the allocation to equities to better match their risk tolerance.

Replacing a target-date fund with an alternative strategy depends on which investments are available through your retirement plan. In some cases, it may make sense to use a target-date fund in your 401(k) but complement it with other funds in an individual retirement account.

“Not all retirement plans are built the same,” says James Lee, a financial planner in Saratoga Springs, N.Y. “Some plans I’ve reviewed have solid investment options that we can use to build a diversified portfolio of sub-asset classes. Others do not, and in those cases the target-date fund may be the best choice for the client.”

If target-date funds are sometimes a poor fit for retirement savers, what about retirees? Christopher Mellone, partner at VLP Financial Advisors of Cetera Advisor Networks, suggests they adopt a more bespoke approach to portfolio construction that can both take into account their needs and allow for tactical adjustments. For example, consider a target-date fund that has a 50/50 allocation to stocks and bonds.

“When you request distributions from that fund, it’ll take half from bonds and half from stocks even when markets are off 20% or more in some instances,” Mellone says. “You may be actively selling when stocks are down. We might otherwise tell you don’t touch your stocks, let them recover and draw from bonds instead.”

He suggests swapping out a target-date fund approximately 10 years before retirement, when many investors have a clearer idea of what their retirement lifestyle will look like. Mellone, who works with both retirement plans and retail investors, says he uses portfolios of 10 to 15 funds covering various sub-asset classes and investment styles.

“We can be very granular. If clients request $5,000 per month, there’s a lot of work that goes on behind the scenes,” says Mellone, who is based in Vienna, Va. “At the same time, with regard to longevity risk, this process adds a lot of value over different cycles and can help make their money last much longer.”

Of course, the right strategy for you depends on what kind of investor you are. A customized portfolio has benefits, but also complexity. If you’re a hands-on investor, great. But it isn’t to everyone’s liking.

“It’s about having the discipline to go into your account, check your portfolio allocation, and do all the trades to get you lined back up, and do it with discipline,” says Nathan Zahm, head of goals-based investing at Vanguard. “That’s where the power of a target-date fund or an advisor comes in. The advisor can be a behavioral coach to make sure you stick to your plan. The target-date fund will do it automatically.”

Write to Andrew Welsch at andrew.welsch@barrons.com