If you've ever owned a 401(k), you're probably familiar with a target date fund (TDF). Because of its simplicity, it's been the go-to for many employer-sponsored plans.

But that simplicity has also been criticized. Sometimes referred to as a "one size fits all" investment, many argue it may not be suitable for all investors. So, what is the truth? Let's dive in.

What is a Target Date Fund (TDF)?

A TDF is designed to adjust its allocation as it gets closer to a specific retirement date and beyond. You can almost think of it as a portfolio within a fund. The difference between this and a normal mutual fund is that a TDF intends to change its stock/bond allocation over time.

Now, before we dive further, a quick reminder about allocation between stocks and bonds:

Aggressive vs Conservative

When you have a high allocation in equities (like stocks), this is considered aggressive. When you have a high allocation in fixed income (like bonds or cash), this is considered conservative.

The general idea is that when you favor higher potential returns and risk, you lean more toward equities for their growth. When you favor stability and low risk, you lean more towards fixed income for their preservation.

Handling the allocation duties between these two can be daunting for many new investors. This is where a target date fund may come in handy. It makes this adjustment as you get closer to your retirement year and continues after that year. As a result, you'll see it has a year date attached to the name.

• The further out the date? The more aggressive it is towards equities.
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• The closer the date? The more conservative it is towards fixed income.

Once it passes that date, it will continue to adjust more conservatively. To understand this, the visual below shows a hypothetical example of how a target date fund would operate throughout its course:

Not All Target Funds Are The Same

The illustration above does not represent all target date funds as each one will have a different allocation throughout it's entire course. Differences between them can include their own investment philosophy and investing style.

While target date funds may have the same target date, the allocation might not be the same across the board. This is why it's vital to ensure you understand the allocation inside the fund.

Why Do People Like Target Date Funds?

• Less Work: The fund essentially acts as a portfolio designed to automatically adjust. Considering that most people are not great portfolio managers, this can be a simple way to have a portfolio that does the risk-adjusted heavy lifting for you.
• Diversified: The fund itself is composed of different asset classes, similar to a traditional portfolio, of different types of stocks, bonds, and other asset classes within (again, they vary per TDF). In addition, the fund is already taking over the duties of rebalancing this diversification. So, like the first point, much of the work is done for you.
• Simplicity: I'm a big believer that simplicity makes it easier for people to take action on their finances. If a target date fund allows you to get involved, that is a pro worth highlighting.

While this sounds great initially, there are some setbacks to be mindful of.

Why People Don't like Target Date Funds?

• Matching Risk Profile: Some argue that the portfolio does not carry enough risk throughout its course. Many argue the transition from stocks to bonds occurs too soon and, therefore, is more conservative through its course than it should be. This is undoubtedly the case for a highly aggressive investor who doesn't mind a 100% allocation to stocks for many years or does not want bonds in their portfolio in general.
• Control: Since the fund adjusts on its own, the control is out of your hands. If the fund becomes too conservative, there is no way to revert this within the fund itself unless you add another fund, which maybe defeats the point of a target date fund. For those who are more hands-on or perhaps more aggressive than the planned allocation, this might not be the shoe that fits.
• Higher Expense Ratios: There is more work to operate the fund, which means a cost comes with it. Compared to funds like index funds, TDFs, on average, have higher expense ratios. Very similar to mutual funds, TDFs can be either passive or active, impacting the expense ratio.

Who Is This Right For?

One size might not fit all, but that doesn't mean it doesn't fit anyone. Based on the features, it boils down to involvement and personal preference over anything else. It's great for people who are looking to get started somewhere or to keep the process of investing simple. It saves time having to reallocate and rebalance constantly.

But if you're looking for more control over the allocation and want to create a portfolio that is more customized to your liking and risk preference, other options are probably worth considering.

While this does the heavy lifting for you, investments should be monitored over time. And a target date fund is no exception to this rule. When all else fails, make sure you target monitoring your situation.

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