The Hidden Risks of Target-Date Retirement Funds & Better Alternatives
Investment Strategies | by Jules Buxbaum | Wednesday, February 19, 2025
Target-date funds often appeal to busy professionals, freelancers, and anyone seeking a straightforward way to save for retirement. Yet many investors overlook the subtle risks buried in these all-in-one funds and may not realize there are better ways to structure long-term savings. If you’ve ever wondered how these funds compare to other retirement vehicles, consider exploring our index funds vs. mutual funds guide for more insights.
What Are Target-Date Funds?
Target-date funds typically bundle multiple investments and automatically shift toward bonds or other conservative assets as the designated retirement year nears. They gained traction when the Pension Protection Act of 2006 enabled employers to use them as default investment options in 401(k) plans.
Assets in these funds soared from less than $200 billion in 2008 to more than $2 trillion by 2020, according to industry data. Major providers like Vanguard, Fidelity, and T. Rowe Price now dominate about 70% of the market, and many retirees trust every dollar of their nest egg to these “set it and forget it” products.
Hidden Risk #1: Market Volatility and Sequence of Returns
Market swings can hurt any investment, but target-date funds can magnify the impact if severe fluctuations occur just before or after retirement. This timing risk is known as sequence of returns risk. For instance, one 2010 target-date fund lost over 40% of its value during the 2008 crisis (SmartAsset) at precisely the worst time for older investors.
Relying solely on a predetermined asset allocation may place you in a vulnerable position. A sharp downturn can drain a significant portion of your savings right as you begin to withdraw funds, often of no fault other than the market’s timing.
Hidden Risk #2: One-Size-Fits-All Allocations
Most target-date funds ignore personal details like future income or total wealth outside the fund. Instead, they rely on the assumption that everyone reaching a retirement date around 2030, 2040, or 2050 has similar financial needs.
This approach overlooks how some individuals may still earn income well into their later years. Others might have substantial assets or unique family obligations. A young entrepreneur with significant upfront capital may not need the aggressive path that a target-date fund assumes. Conversely, an older employee with strong future earnings potential may want a higher exposure to equities longer than the fund recommends.
Hidden Risk #3: Potential Underperformance Over Time
Some providers follow “to retirement” glide paths, meaning their portfolio becomes extremely conservative by the stated year. Others use “through retirement,” continuing small allocation shifts after that target date. Neither approach guarantees protection from sharp drawdowns, nor do they necessarily outperform custom portfolios.
One study by Morningstar found that the difference in returns between the highest and lowest performers among 2025 target-date funds was over 12 percentage points in a single year. That’s a wide range for products marketed as steady solutions. Additionally, many investors pay layer upon layer of fees since these funds often hold multiple underlying mutual funds.
Better Alternatives to Target-Date Funds
Investors seeking more control might consider balanced funds, which maintain a fixed distribution of stocks and bonds. Others opt for building a custom mix of index funds and bond funds at lower expense ratios. Exploring inflation risk is also important when choosing your asset allocation.
Robo-advisors have become popular for their algorithmic, data-driven approach. These platforms can tailor portfolios to your specific age, goals, and risk preferences, making adjustments more dynamically than a target-date fund. Another approach includes managed accounts, available through some 401(k) plans, which assign a professional manager to customize your investments. If do-it-yourself volume appeals to you, you might combine several low-cost index funds, such as a U.S. equity index, an international equity index, and bond indexes.
For those who want deeper forecasting capabilities, 2Pi Financial offers a Financial Planning Engine (found at 2pifinancial.com/2pi-financial-planner). This tool illustrates how tweaking variables like retirement age or savings rate can significantly affect long-term feasibility, giving you a more precise roadmap than a one-size-fits-all fund.
Why Personalized Planning Matters
Kit-based retirement solutions often disregard whether you’re just getting started or already set for retirement. A universal “glide path” rarely accounts for substantial shifts in personal circumstances. You might receive a windfall, experience a large salary increase, or decide on partial retirement.
If you find yourself anxious about insufficient savings, check out our resource on what to do if you’re behind on retirement savings. That step-by-step plan can be more effective than relying on the default schedule of a target-date fund.
Retirement planning is most successful when it’s both individualized and flexible. Even the best target-date fund can’t account for every health issue, career shift, or late-life investment opportunity. Aligning your plan with these details allows you to maintain or even expand equity exposure if you have strong future earnings. Alternatively, you can reduce market risk if you already have enough saved and prefer stability.
Key Takeaways for Building a Stronger Retirement Strategy
To shield your wealth from the hidden pitfalls of target-date funds, a personalized portfolio is often the better way forward. Here’s a brief summary of what a sturdier approach can look like:
- Combine low-cost index funds and bond funds to retain flexibility.
- Keep an eye on your real-life earnings potential instead of a static timeline.
- Set up a planning tool that allows toggling factors like retirement date and withdrawal rates.
- Review your choices regularly—quarterly or annually—and make adjustments in line with your changing goals.
This balanced strategy creates room to add or reduce risk based on actual data rather than an arbitrary date.
Final Insights
Picking a target-date fund may seem simple, but the convenience can conceal vulnerabilities that arise just when you need stability the most. Personalized strategies offer more flexibility and can often deliver stronger outcomes over the long haul, especially for those with evolving career paths and income.
If you are ready to shape a portfolio that adapts to your circumstances, you can also learn how to diversify your retirement portfolio. It is a proactive step to fortify your wealth and reduce unwelcome surprises when you finally stop working.
References
1. Morningstar. (2022). “Target-Date Funds Have Suffered Losses. What Should Near-Retirees Do?” Available at: https://www.morningstar.com/funds/target-date-funds
2. SmartAsset. (2019). “Are Target-Date Funds Hampering Your Retirement? Try This Instead.” Available at: https://smartasset.com
3. Investopedia. (2023). “Target-Date vs. Index Funds: Is One Better?” Available at: https://www.investopedia.com
4. Vanguard. (2023). “How Target Retirement Funds Work.” Available at: https://investor.vanguard.com
5. Rebalance360. (2023). “Target-Date Funds.” Available at: https://www.rebalance360.com
6. NBER. (2020). “Optimal Portfolio Allocation Across an Investor’s Lifetime.” Available at: https://www.nber.org
7. Lucia Capital Group. (2022). “Hidden Risks in Target-Date Funds.” Available at: https://www.luciacap.com
8. PGIM. (2021). “Few Retirement Plans Offer Alternatives Within Target-Date Funds.” Available at: https://www.pgim.com
