Target-Date Funds: What You Pay for the Convenience

A target-date fund at 0.55% against the same thing built yourself at 0.06%, on $500 a month for thirty years, costs $55,068. That is 9.1% of the final balance, and most people should pay it anyway.

That is an odd position to hold after showing a number like that, so the rest of this piece is the argument for it. The short version: the honest comparison is not against a perfectly maintained portfolio, it is against what people actually do.

What is the fund doing on your behalf?

Three jobs, and they are worth separating because they are not equally valuable.

It chooses the allocation. A 2055 fund decides what share of your money sits in US stocks, international stocks and bonds, and it does that with no input from you. The SEC's investor bulletin on target date funds is clear that the year in the name is a design assumption rather than a promise, and that two funds with the same year can be built very differently.

It rebalances. When stocks run and the mix drifts, the fund trades back to target without asking. This is the job that sounds smallest and is probably the most valuable, because it is the one that requires an action in exactly the months nobody wants to take one. Selling what has gone up in a good year, and buying stocks in a bad one, is easy to describe and hard to do.

It shifts you towards bonds as the date approaches. The glide path. This is the job that people most often think they are buying and that is most open to argument, because there is no agreement on what the right path is.

The glide path, and the disagreement about it

Every provider has a different one, and the differences are not small.

The distinction that matters, and that almost nothing explains, is "to" against "through". A "to" fund reaches its final, most conservative allocation at the target year and holds it. A "through" fund is designed to keep going past the target, shifting gradually for another ten to thirty years, on the assumption that you will draw the money down over decades rather than spend it on the day.

The consequence is that two funds both labelled 2040 can hold materially different amounts of stock in 2040. One might be at 35% stocks and the other at 55%. If you had planned to buy an annuity or spend the balance in the first few years, that gap is the difference between the plan working and not.

Finding out which yours is takes about four minutes: open the fund's page or prospectus and look for the glide path chart or the words "to retirement" and "through retirement". Nobody checks this, and it is the most consequential thing in the product.

The fee difference, over thirty years

$500 a month, thirty years, 7% a year before fees. A target-date fund at 0.55% against a self-built equivalent at 0.06%.

$55,068 is 9.1% of the larger balance and is worth 9.2 years of the $6,000 annual contributions. It is a real cost and nobody should pretend otherwise, which is the same mechanism set out in what 0.85% actually costs you.

Two things are worth reading out of that table rather than past it.

The gap after ten years is $2,285. At the point where you might still change course cheaply, the cost is invisible, and by the time it is visible the balance is too large for the switch to recover much of it.

And 0.55% is a mid-range figure, not a universal one. Index-based target-date funds from the large providers charge under 0.10%, at which point the gap against a self-built portfolio falls to a few thousand dollars over thirty years and the entire argument evaporates. Check your own fund's ratio before deciding you are being overcharged, because you may not be.

Who genuinely should not hold one

Four cases, and the first is the common one.

If you hold taxable and tax-advantaged accounts together. A target-date fund puts bonds in whatever account it happens to live in, and bonds generate ordinary income taxed at your marginal rate. Holding bonds in a 401(k) and stocks in a taxable account is worth real money to a higher-rate household, and a target-date fund cannot do that because it does not know what else you own.

If you would genuinely rebalance. Not "would like to". Have you, in a year when it meant buying stocks after a fall? If the answer is yes, twice, then the $55,068 is buying you something you already do, and the three-fund portfolio costs you an hour a year. How often is enough is less often than most people think.

If your retirement date is not your spending date. Someone retiring at 55 with a pension starting at 67 has a twelve-year gap the glide path knows nothing about. The date on the fund is a proxy for a spending pattern, and if yours is unusual the proxy is wrong.

If your plan's target-date option is expensive and its index funds are not. Some menus offer a 0.68% target-date fund beside an S&P 500 index fund at 0.04%. That is a $70,000 decision over a career and it deserves twenty minutes.

So which one

If your plan's target-date fund is under about 0.15%, use it and stop thinking about this. It is doing three useful jobs for almost nothing.

Between 0.15% and 0.40%, still use it unless you have actually rebalanced a portfolio before. The fee is a maintenance contract, and most people need one.

Above about 0.50%, look at what else the plan offers. If there is a broad index fund at under 0.10%, building it yourself is worth the annual hour. If there is not, hold the target-date fund and move the money to an IRA when you leave, which is what what to do with an old 401(k) covers.

We would rather someone held an expensive target-date fund for thirty years than a cheap portfolio they stopped maintaining in year four, because the second person's allocation drifts to whatever the market left them with. The $55,068 is a large number and it is smaller than the cost of getting the allocation wrong for a decade.

When this does not apply

If you hold a target-date fund alongside several other funds. Then it is not doing its job. It is designed as the entire portfolio, and mixing it with an S&P 500 fund and a bond fund produces an allocation nobody chose and nothing maintains. Pick one approach.

If you are within five years of retiring. The glide path question stops being theoretical, and the "to" against "through" distinction now decides how much stock you hold when a bad year would hurt most. Read the prospectus, and see asset allocation by age and its limits for why age alone is the wrong variable.

If the fund is your only holding in a taxable account. Target-date funds are usually less tax-efficient than holding the components separately, because rebalancing inside the fund can generate distributions. This matters little in a 401(k) and more outside one.

If your plan wraps the fund in an insurance product. Some plans, particularly smaller ones, offer target-date options inside annuity contracts with their own charges stacked on top. The headline expense ratio is then not the whole cost, and the total is in the plan's annual fee disclosure rather than on the fund page.

Next steps

1. Find your target-date fund's expense ratio. It is on the fund page and in your plan's annual fee disclosure.
2. Compare it with the cheapest broad index fund your plan offers. If the gap is under about 0.10%, stop here.
3. Check whether yours is a "to" or a "through" fund, and look at what it holds in the target year.
4. Check you are not also holding other funds alongside it.
5. If you hold accounts outside the plan, look at your combined allocation rather than each account separately.