Eight in 10 401(k) savers are invested in target date funds (TDFs). That's according to Vanguard's "How America Saves 2021" report, an in-depth look at 401(k) plans and how U.S. workers are preparing for retirement.

The growing popularity of TDFs isn't surprising. More 401(k) plans are adopting automatic enrollment, which selects TDFs for plan participants by default.

TDFs are also easy to own, relative to other securities. They maintain a defined asset mix that gradually gets more conservative over time. If you trust the TDF strategy, you don't need to do much -- the fund is positioned for growth in your younger years and then capital preservation as you near retirement.

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Still, TDFs aren't infallible. You can easily end up in the wrong one, which will make it harder to reach your retirement goals.

Here are four ways your TDF investment can fall short, and how to avoid them.

1. The TDF is too aggressive

The common advice is to choose the TDF that aligns with your expected retirement year. This is the simplest approach, but it could leave you with more risk than you want.

Every TDF has a plan, called the glide path, for shifting fund assets from aggressive to conservative over time. These plans generally fall into one of two categories: "to" glide paths and "through" glide paths.

  • A "to" glide path reaches its most conservative asset mix in the target year. This insulates you from market volatility thereafter but also limits your growth.
  • A "through" glide path reaches its most conservative mix some time after the target year. This gives you more growth opportunity later in life but could create more volatility than you want.

The "to" and "through" formats are both valid. What's important is that you know which one you own. A bad surprise can happen when you think you have a "to" fund, and you're really invested in a "through" fund. In that scenario, you'd expect stability from your 401(k) in your retirement year. If you instead face more volatility than expected, you could end up in a difficult situation.

Avoid this fate by reviewing the glide path for your TDF, and make sure it aligns with your risk tolerance and expectations. If the fund looks too aggressive, for example, switch to an earlier target year.

2. The TDF no longer matches your retirement timeline

You may have looked over your TDF's strategy ages ago. If your retirement timeline has changed since then, it's time for a check-in.

Say you've delayed your scheduled retirement by five years, thinking you'd use the time to fatten your savings balance. A conservative "to" TDF isn't likely to offer strong returns during your five-year delay. If you can tolerate additional risk, you may prefer a fund that's geared for moderate growth in those final working years.

Plan on reviewing your TDF periodically. If the fund no longer aligns with your retirement timeline and goals, you'll want to know quickly so you can make the necessary changes.

3. The TDF has high fees

TDFs, like all mutual funds, pass along their operating expenses to shareholders. These expenses are quoted to you as the fund's expense ratio.

Expense ratios cut into the fund's investment returns. For that reason, it's best to keep them as low as possible. A low expense ratio provides an easier path to competitive returns for shareholders.

A Morningstar report pegs the 2018 average expense ratio for TDFs at 0.62%. If your fund's expense ratio is higher, you might want to adjust your retirement strategy. The options you have are:

  • Formally request lower-fee funds from your 401(k) administrator. This may not go anywhere, but it doesn't hurt to ask.
  • After you max out your employer match, send excess contributions to your IRA. You'll have a broader range of investment options in that account. See the next point below for tips on owning other assets alongside your TDF.
  • Consider shifting to an index fund strategy if you're willing to monitor your asset allocation. Index funds typically have very low expense ratios.

4. The TDF doesn't fit with other retirement assets

A TDF's asset mix is designed to align with your retirement timeline. If you hold a TDF alongside other securities, your overall asset mix will differ from the TDF's. For example, a TDF and an S&P 500 index fund together would provide greater stock exposure -- and probably more risk than you may want.

The solution is to build your retirement portfolio with a single TDF. That can be challenging, though, if you have retirement funds in multiple accounts. The TDF in your 401(k) may not be available in your IRA, or vice versa. In that case, you have two options:

  • Look for similar TDFs. Compare glide paths and pair up funds that have parallel strategies.
  • Replicate the TDF's asset mix with index funds. If your 401(k) TDF holds 65% stocks and 35% bonds today, build the same exposure in your IRA with index funds. Then, adjust the mix in your IRA annually so it remains aligned with your TDF.

Retirement success with TDFs

TDFs are low maintenance, but they're not maintenance-free. To get the most from a TDF, you should do some research upfront, reevaluate your timeline periodically, and be strategic about choosing other assets in your retirement portfolio.

These are manageable action items that can keep risk in check and support better returns. Long term, that should streamline your journey to reaching your retirement savings goals.