Sandy Francis is living proof that investing for retirement needn't be complex. The co-owner of Colorado-based Veda Salon & Spa says set-it-and-forget-it target-date funds are the cornerstone of his firm's 401(k) plan. He and most of his 180 employees use these retirement accounts to put their planning on automatic pilot.

"They have an appropriate mix of investments, they're automatically rebalanced, and they're low cost," Francis says. "If you choose that kind of fund, you don't have to worry about anything."

Over the past decade, target-date funds have taken the retirement-planning world by storm. These types of accounts hold a variety of investments in a mix that gradually becomes more conservative as participants age and get closer to their "target" year--presumably the start of retirement. Because they take the most vexing decisions out of your hands--like how much of your portfolio should be invested in stocks versus bonds, or international versus domestic assets--they can help you avoid costly mistakes, from panic-selling to return-chasing.

"We humans are predictably irrational," says Allan Roth, founder of Wealth Logic, a financial-planning firm based in Colorado Springs, and Veda's retirement adviser. "We jump into investments after they've gone up, and get out of them after they've gone down. If we're offered too many investment choices, we throw up our hands and keep our assets in cash."

Target-date funds are "funds of funds." Instead of picking individual stocks and bonds, they invest in other mutual funds to create a broad mix of investments. This mix adjusts gradually to match your investor risk profile: For young people, it emphasizes growth and takes more risk to achieve it; for those close to retirement, it's focused on safer investments that preserve capital. So when you're just starting out professionally, your target-date fund will invest primarily in volatile but historically high-return assets, such as domestic and international stocks. Every year, as your retirement gets nearer, an incremental portion of the portfolio is shifted into historically safer havens, such as bonds and cash. For instance, Vanguard's Target 2045, geared to those retiring three decades from now, has nearly 90 percent of its assets in stocks. The Target 2020 fund, on the other hand, has more than 40 percent of its assets in bonds.

Launched in the 1990s, target-date funds now account for $1.3 trillion, or roughly one-fifth, of assets in defined-contribution retirement plans, such as 401(k)s, according to Sway Research. And they're even more popular at big companies. An index compiled by Callan Associates, a San Francisco-based money-management firm, indicates that these funds now hold nearly 28 percent of all assets in the big defined-contribution plans it tracks--up from just 5 percent in 2006.

Part of that growth is due to a 2006 rule that allows plan sponsors to make target funds a default option for employees who fail to make investment elections within their plan. Previously, if an employee didn't choose an investment, his or her retirement contributions were placed in money-market and stable-value funds, which often earned much less than target-date funds.

Of course, target-date funds might not be the best choice for your retirement. If you're exceptionally rich or investment savvy, you may be able to structure a smarter portfolio tax-wise. So do target-date funds make sense for you? Here's what you need to know.

They're not all alike

"Set-it-and-forget-it" describes all target-date funds. But every mutual fund company takes a different approach to the investment selection, fees, and so-called glide path, the speed and extent to which the fund's investments become more conservative over time. Though low fees are best when everything else is equal, there is no consensus about the best glide path or the ideal investment mix. And some investors may be happy to pay higher fees for a fund that's better suited to their personal investment strategy.

Francis chose Vanguard Target funds for Veda's 401(k) at Roth's suggestion. The adviser favors Vanguard Target funds because they charge the lowest fees, while still providing a simple but widely diversified mixture of investments. Vanguard uses just four or five stock-index or bond funds in each of its target-date options--but each of those index funds holds literally thousands of individual securities in companies of all sizes, which provides a terrific level of diversity in a straightforward package, Roth says. And the fees can't be beat, ranging from 0.10 to 0.16 percent of assets annually.

The target-date offerings from T. Rowe Price are more complex, mixing as many as 18 funds. They also charge more for more active management, costing investors roughly 0.7 percent of assets each year. However, the funds have performed well. T. Rowe's 2025 target fund, for example, earned 9.75 percent over the past five years, compared with 8.86 percent for the comparable Vanguard fund.

Mutual fund giant Fidelity Investments also offers a complex target account, folding more than a dozen underlying funds into its Freedom 2025 and charging investors nearly 0.7 percent of assets each year. It also has a less-expensive, passively managed option with fees at 0.15 percent. However, unlike the T. Rowe option, neither has performed as well as Vanguard's simpler, passively managed alternative in recent years.

They're not for everyone

If you save both inside and outside of retirement accounts, target-date funds are probably not your best option, for tax reasons, says Roth. He suggests that well-heeled investors mimic the investment mix of target-date funds, but do it with a savvy asset-location strategy. Put assets that are taxed at a low rate, like stock-index funds, in taxable accounts; put those taxed at higher rates--bonds and REITs--in your retirement accounts, like IRAs and 401(k)s, since they are tax-deferred. This can minimize your tax bill and maximize what you have left to spend.

But for everyone else, Roth endorses the simplest retirement option. Target-date funds "allow you to harness the most powerful force in the universe--inertia," he says.
"Leaving your investments alone in a low-cost fund allows you to avoid a lot of costly mistakes."

Hitting the bull's-eye

Target-date funds are some of the most popular offerings from big defined-contribution plans, according to a 2017 survey from Callan Associates:

  • 92.9 percent of plans offer target-date funds in their investment lineup
  • 88.2 percent use a target-date fund as the default option for employees who fail to make investment selections
  • 54.1 percent offer online investment advice through a service such as Financial Engines
  • 43 percent offer one-on-one advisory services
  • 13.3 percent provide full financial-planning services as part of the defined-contribution retirement plan