Target-Date Funds vs. Lifecycle Funds

When considering investments for your 401(k) plan, you might see options listed as target-date funds or lifecycle funds. These are actually the same type of fund. They’re structured to minimize risk and maximize returns at a specific date.

Target-date or lifecycle funds automate some aspects of portfolio management, and they are ideal for investors who don’t want to actively manage their portfolio. So they’re a popular option for 401(k) accounts. However, there are some downsides to these funds.

In this article, we’ll take you through the pros and cons of target-date or lifecycle funds. That way, you can better choose investments for your 401(k) portfolio.

Understanding Target-Date and Lifecycle Funds

The wide range 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 pick a fund that targets the date you want to retire, such as 2050. Then, you put money into it. The fund will be managed according to some 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 as they remove the need for you to research and manage the investments.

In practice, target-date and lifecycle funds gradually get 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 initially will be aggressive. In 2025, the fund might hold 80% stocks and 20% bonds, but there will be more bonds and fewer stocks in the fund each year. By 2035, you will be halfway to the target date, so the fund might be 60% stocks and 40% bonds. Finally, the fund may reach 40% stocks and 60% bonds by the target retirement date of 2050.

Using 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 put a target-date or lifecycle fund in your 401(k) and — in theory — watch it grow until you retire. This autopilot feature is the major advantage of target-date or lifecycle funds.

Just as with any investment, however, there are some drawbacks to consider. The automated changing of the portfolio assets may not suit your investing goals. For example, you may want to invest differently if you plan to retire before the target date on the fund or want to keep working after that date.

An investor should be aware that target-date or lifecycle funds have fairly high fees. That's because the investor is responsible for paying both the fees charged by the target-date or lifecycle fund and the expense ratios of the underlying funds that are owned.

Target-date or lifecycle funds can also potentially complicate your asset allocation if you hold other assets. These funds are designed to maintain an optimum asset allocation across the life of the fund, and investing in other assets alongside this could upset this fine balance. Some investment professionals advise against investing in other assets if you hold target-date or lifecycle funds.

The Bottom Line

Target-date funds and lifecycle funds are a type of fund designed to optimize your returns and minimize your risk through a particular date. These funds are a popular choice for 401(k) investors because they don’t require ongoing management. However, they are relatively inflexible and can come with high management fees.