How the Right Target-Date Fund Could Make You $400,000 Richer

Target-Date Funds hold a mix of stocks and bonds and get more conservative as investors age. (Dreamstime)

Target-date funds are at the center of millions of Americans 401(k) plans. Over the past 15 years some have performed a lot better than others.

Target-date mutual funds hold more than $4 trillion, in large part due to a 2006 law that helped enshrine them as the default in millions of Americans 401(k) plans. The funds typically own a mix of stocks and bonds that grows more conservative as the target dates meant to correspond with a saver’s retirement year approaches.

Fund performance varies widely. Which fund you choose—or gets chosen for you—could end up making a difference of hundreds of thousands of dollars when it comes time for retirement, according to a recent study by fund researcher Morningstar.

Morningstar looked at how 37 different target-date 2025 funds performed between 2010 and the end of last year. Investors presumably would have bought these funds at around age 50 and be set to hit the typical retirement age of 65 this year.

The median fund posted average annual returns of 6.6% between 2005 and 2024, Morningstar found. That’s far below the S&P 500’s mark of 13.8%—but that’s to be expected. After all, the funds are investing for workers about to enter retirement. The typical target 2025 fund has just under 50% invested in stocks today, according to Morningstar’s report. While stocks have soared, bonds struggled over the past 15 years, returning only about 2.4% a year on average.

What may be more surprising is the gap between top- and bottom-performing funds. The best performer Callan Glidepath 2025 returned 9.1% a year, on average. The worst performer, Putnam Sustainable Retirement 2025, returned 5.3%.

When translated into retirement savings that discrepancy is significant. A saver who made $75,000 a year in salary and had $300,000 in retirement savings in 2005, would have had $1.25 million at the end of last year in the Callan fund, compared with just $785,000 in the Putman one, Morningstar calculated. (The study also assumed the saver received 2% annual raises and saved 7% of his or her annual salary.)

One reason the Putnam fund lagged behind its competitors is its conservative bent: The fund has only about 27% of its assets invested in stocks, compared with more than 40% in similar funds in its Morningstar category. Putnam didn’t immediately respond to a request for comment.

How did some of the most popular target-date options perform? Vanguard Target Retirement 2025 fund posted average annual returns of 7.8%; American Funds 2025 Target Date Retirement returned 8.1% and Fidelity Freedom 2025, 7.2%.

Investors looking at these results should consider some caveats—but also some potential lessons.

Stocks have had an unusually good past decade and a half, while bonds have endured one of their worst stretches in memory. Conditions are likely to be different over the next 15 years.

Still, 401(k) investors may want to look up the stock-bond mix of their own 401(k) plan’s target-date fund, and if they don’t like it, build a portfolio from the plan’s menu of stock and bond funds that’s more to their liking.

Today, the typical target-date fund for savers retiring in 15 years has about 75% of its assets invested in stocks. That’s probably a reasonable amount if you consider these funds’ role as 401(k) defaults—fund managers are overseeing money on behalf of thousands of savers who might not know much about stock market volatility; the onus is on them to be conservative.

But more sophisticated investors might want to risk being more aggressive. Fifteen years is plenty of time to ride out even the most severe of bear markets. And when you are investing for the long-term, an extra percentage point or two in annual performance can make a huge difference.

Write to Ian Salisbury at ian.salisbury@barrons.com