When considering investments for your 401(k) plan, you may see options listed as target date funds or lifecycle funds. It is in fact the same type of fund. They are structured to minimize risk and maximize returns on a specific date.
Target date or lifecycle funds automate some aspects of portfolio management, and they’re ideal for investors who don’t want to actively manage their portfolio. They are therefore a popular option for 401(k) accounts. However, these funds have some drawbacks.
In this article, we’ll walk you through the pros and cons of target date or lifecycle funds. This way you can better choose the investments for your 401(k) wallet.
Key points to remember
- Target date funds and lifecycle funds are the same type of fund.
- Target date and lifecycle funds are designed to maximize your returns and minimize your risk at a target date.
- As the target date approaches, target date and lifecycle funds gradually make your portfolio more conservative.
- Many 401(k) investors prefer target date and lifecycle funds because they don’t require ongoing research and maintenance.
- However, target date and lifecycle funds are relatively rigid and can incur high management fees.
Understanding Target Date and Lifecycle Funds
The wide array of options available in the average 401(k) can be confusing. The terminology used to describe these investments can add to the confusion. For example, “target date”, “lifecycle” and “age-based” funds are all terms used to describe the same type of fund.
The concept behind these funds is simple. First, you choose a fund that targets the date you want to retire, like 2050. Then you put money into it. The fund will be managed according to a version of modern portfolio theory so that, at least in principle, the fund maximizes returns and minimizes risk until the target date. These funds are, in other words, a kind of autopilot for your retirement investments because they save you the trouble of researching and managing investments.
In practice, target date and lifecycle funds become progressively more conservative as their target date approaches.
If, for example, you invest in a lifecycle fund with a target retirement date of 2050, the fund will initially be aggressive. In 2025, the fund could hold 80% stocks and 20% bonds, but there will be more bonds and fewer stocks in the fund each year. In 2035, you will be halfway to the target date, so the fund could be 60% stocks and 40% bonds. Finally, the fund could reach 40% equities and 60% bonds by the target retirement date of 2050.
Target date and lifecycle funds also carry the risk inherent in investing in the stock market. It could be that a bull market will start and end just in time to keep the fund competitive at the target date. Or one bear market could decimate the fund’s holdings just months before the target date.
Use of target date and lifecycle funds
Many investors are drawn to target date or lifecycle funds because they automate much of the work of portfolio management. Instead of spending hours researching investment options, you can place a target date or lifecycle fund in your 401(k) and, in theory, watch it grow until you retire. This autopilot function is the main advantage of target date or lifecycle funds.
However, as with any investment, there are disadvantages to consider. Automated portfolio asset switching may not suit your investment objectives. For example, you may want to invest differently if you plan to retire before the fund’s target date or if you want to continue working after that date.
Also, relative to other investments, target date or lifecycle funds can be expensive. They are technically a funds of funds (FoF)– a fund that invests in other mutual funds or exchange-traded funds (ETFs) – which means you have to pay the expense ratios of those underlying assets, as well as the target date fund’s fees or of the life cycle.
Target date or lifecycle funds can also potentially complicate your asset allocation if you hold other assets. These funds are designed to maintain an optimal asset allocation throughout the life of the fund, and investing in other assets at the same time could upset this delicate balance. Some investment professionals advise against investing in other assets if you hold maturity or lifecycle funds.
What is the difference between target date funds and lifecycle funds?
Target date funds and lifecycle funds are the same thing. They are both a type of fund optimized to generate returns and reduce risk until a given date.
Are target date or lifecycle funds a good 401(k) investment?
Whether target date or lifecycle funds are ideal for you will depend on your investment style, level of knowledge and ability to manage your own investments. These funds automate portfolio management for you, but at the cost of rigidity and potentially higher fees.
Are target date or lifecycle funds low risk?
Target date or lifecycle funds can be considered low risk, but the risk varies by fund. Any investment in the stock market involves risk. There is no guarantee that the funds will produce high returns on their target date.
The essential
Target date funds and lifecycle funds are a type of fund designed to maximize your returns and minimize your risk up to a specific date. These funds are a popular choice for 401(k) investors because they don’t require ongoing management. However, they are relatively rigid and can lead to high management fees.
