If you hang around the personal finance space very long, particularly in the FIRE community; you will hear someone throw shade at target date funds. A target date fund is simply a “fund of funds” arrangement where the investor picks a date in the future and the fund’s algorithm picks a mix of funds to achieve a targeted asset allocation. For instance, a young investor just starting might pick a date 40 years into the future that aligns with their retirement. That fund would be quite aggressive, likely 90% stocks and 10% bonds. The fund would then automatically adjust and rebalance to become more conservative over time. That fund would likely be 50% stocks and 50% bonds near the target date and adjust even more conservative at dates past retirement. 

The basic idea with asset allocation is that the longer you have until you need the money, the more aggressive (ie. more stocks) you can be with your investments. 

The common criticisms are that the target date funds become too conservative too quickly. A person might be in a 60/40 position a full decade before retirement and be too conservative in retirement as well. Some funds will hold just 20% in stocks in the decade after retirement. Such bond heavy portfolios are good for risk mitigation, but may not generate sufficient income. The other criticism is that the funds are prepackaged around a target date without regard for an individual’s unique financial circumstances. They’re a “one size fits most” kind of arrangement.

I have to admit, I’ve uttered these very criticisms and think they’re valid. So then, why would I recommend them to friends and acquaintances? I believe that a reasonably competent investor with a grasp of market fundamentals, effective risk management, and good temperament can beat the returns of a target date fund over an investing career quite handily. The objections among the personal finance enthusiasts are that a target date fund isn’t an optimal solution. 

And they’re exactly right, target date funds aren’t optimal for anyone. 

I’ve become less critical over time about target date funds, simply because I’ve met and talked with quite a few investors. I believe target date funds are best appreciated for what they are the alternative to, not for what they optimize. While there are investors who are quite adept at saving and investing, that isn’t the majority of them and target date funds were never intended to be the investing tool of the savvy and adept. In fact, just the opposite. I’ve met a lot of folks who fall into the following two broad categories. 

The Do Nothings– these folks don’t know about investing and really don’t care to learn. They aren’t passionate about personal finance or plan for their own financial futures. They don’t sign up for the company 401k and leave their matching funds on the table. If they do participate in the 401k, they frequently won’t even select an investment and let their money linger in the “stable value fund” getting eaten by inflation.

The Ham Fisted– these folks want to invest money for the future but tend to be pretty sloppy about it. They pick inappropriate funds to invest in. They move money in and out of the market with every headline. They may simply put 10% in each of the plan’s 10 funds thinking they’re achieving “diversification”.  They chase returns. They buy high and sell low. As a result, they tend to generate a lot of activity but gain very little.

I would offer that these two broad categories making up a large cadre of retirement investors have the most to gain from target date fund investing. With the Secure Act 2.0, many companies auto-enroll new employees into the 401k plan and the target date that most closely aligns with their 65^th birthday is the default investment. Since the target date fund auto balances and adjusts the asset allocation automatically, savers simply have to focus on saving and there are no dials to tinker with or maintenance to perform. A new worker could simply “set it and forget it” for 40 years and still have a relatively good retirement outcome that isn’t too risky nor too risk adverse. 

While it is true that simply phoning it in for 4 decades isn’t optimal, it sure beats what would have happened had someone not saved anything at all or sloshed funds around the market chasing fads and running from their fears. Not everyone has the temperament or aptitude to delve deep into retirement investing, for those folks the target date fund might be the best thing that’s happened this side of the pension.

Once you consider what the target date fund is the alternative to, it really is greater than the sum of its parts.