Target date funds and model portfolios both simplify 401(k) investing by automatically diversifying and managing your portfolio’s asset allocation. However, they take different approaches. Target date funds focus on a specific retirement year, while model portfolios let you choose your investment strategy based on your comfort with risk and estimated retirement date. Both can be effective tools for building long-term wealth.
Key Takeaways:
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Model portfolios and target date funds make it easier for busy and/or inexperienced investors to diversify and build their retirement investment portfolio.
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Target date funds follow a one-size-fits-all approach for the retirement year you select, but their limited transparency on asset allocation management can lead to unexpected costs and risks.
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Model portfolios empower investors to choose the investment portfolio most aligned with their personal time horizon and risk tolerance, but may require occasional adjusting (perhaps every 5 to 10 years) as retirement approaches.
What is a Target Date Fund?
A target date fund automatically adjusts its mix of investments over time, ideally becoming more conservative as the user gets closer to their selected target retirement date. They are meant to make selecting 401(k) investments as simple as possible, but can include unexpected costs and risks.
To use a target date fund, investors pick the year around when they expect to retire, and that’s it. Target date funds adjust their asset allocations to be more conservative as the fund approaches its target year. For example, a fund designed for retiring in 2030 should currently have a much more conservative allocation than a 2060 target date fund. Digging in deeper, an investor might notice a higher bond-to-stock mix in a more conservative fund while an aggressive portfolio may have no bonds in its allocation at all.
However, it’s not all roses with target date funds. Target date funds don’t consider that people of the same age have different risk tolerances and goals, instead taking a one-size-fits-all approach.
Investors also rely on the fund's manager to properly reduce risk as the target year approaches (the methodology should be disclosed in the fund prospectus). Some target date funds may invest over aggressively as happened for too many during the Great Recession.
Target date funds also tend to be more expensive than self-built portfolios. Most are structured as a “fund of funds,” adding an extra layer of expense.
Model portfolios, on the other hand, may or may not charge an additional expense. For example, the investment management expense is the same whether you choose a model portfolio or build your own portfolio at ShareBuilder 401k.
Talk to our retirement experts today to find the right plan for you.
What is a Model Portfolio?
Model portfolios, also known as risk-based portfolios or target risk funds, customize a mix of asset classes to match the specific risk tolerances and time horizons of investors. These portfolios typically range from very conservative to aggressive, allowing investors to choose what best fits their financial goals and life situation.
Model portfolios tend to be much more precise than a target date fund on their ability to align with an investor’s needs, though they do require occasional adjusting as investors get closer to retirement (perhaps every 5 to 10 years).
Not sure what your risk tolerance is? Take our quick online quiz to find an investment strategy that fits your needs.
In a 401(k), the financial goal is pretty straightforward – build your savings so you can retire. However, you may or may not be comfortable with big market swings, and you may be nearing retirement or decades away, so time horizons vary.
For example, if you’re 25 and have decades before retirement, an aggressive model portfolio could be a good fit because you’ll have time to recover from sudden losses. Or perhaps you are 62 and thinking about retiring in a few years? If market volatility is something you want to minimize the impact of, a conservative portfolio is a nice solution.
Model portfolios provide the flexibility to adjust your approach as your goals change, though they do require attention over time.
Most importantly, model portfolios provide transparency. You can easily see the funds, allocation, costs, as well as time horizons and risk goals. Target date funds, on the other hand, can be harder to understand. They typically require investors to dive into the fund sheets and/or prospectuses to track how asset allocations will change.
Our view is that model portfolio transparency and risk tolerance alignment are most critical for investors, and it is worth the minimal effort to switch portfolios every decade. Look for model portfolios with automatic rebalancing, so your asset allocation remains in line with your investing goals and risk tolerance.
Balanced Portfolio Example
Here is an example of a balanced model portfolio that clearly shows its mix of investments, designed for someone with a moderate time horizon and medium risk tolerance. It offers an equal mix of growth and income-generating investments. View important disclosures.
Please note that this is only intended as an example, and that assets are chosen based on based on their historical performance. Ultimately, past performance is not a guarantee of future results. View our current model portfolios here.
Which Is Better: a Model Portfolio or a Target Date Fund?
The choice depends on your personal situation. This chart helps summarize the key differences:
| Features | Model Portfolios | Target Date Funds |
|---|---|---|
| Customization | High – enables user to pick the model that best aligns with their risk tolerance and time horizon, typically 5-7 options from stable to aggressive | Low – one-size-fits-all for the target date a user selects |
| Ease of Use | Simple – select from the model that best aligns with your goals | Very simple – pick the date you want to retire and you’re done |
| Transparency | Transparent – funds, allocation, costs, time horizon, and risk goals are spelled out | More opaque – user will need to dive in the fund sheet and/or prospectuses to understand asset allocation and how it adjusts over time |
| Expenses | Lower – usually made with ETFs and/or index mutual funds, and there may not be an added investment management expense vs building your own portfolio | Higher – typically include multiple layers of management fees and contain funds of funds |
| Rigor to Manage Investment Risk | High – designed to manage risk in line with varying time horizons with clear asset allocation, but requires you to review your selection over time | Medium to low – history of being more aggressive than prudent as the fund approaches its target date |
What to Look for When Selecting a Model Portfolio or Target Date Fund?
The best model portfolios and target date funds are built with index funds, often exchange traded funds (ETFs), versus those consisting of actively managed mutual funds. Using index funds almost always keeps the fund expenses lower than other options, enabling more of your money to stay invested in the markets and grow over time. Look for expense ratios ranging from 0.03% to 0.10%.
Model portfolios typically display their fund composition and how it varies from stable to aggressive, so you can get a real sense of how risk is managed and the investments that can drive your returns. Target date funds will likely take some digging in the prospectus or fund report to uncover how they are composed, and how they plan to adjust the asset allocation as time passes.
It’s important to understand this so that you are comfortable with the funds selected. Lastly, if you select a model portfolio, it’s important to ensure auto-rebalancing is in place (may need to be turned on). This way your investments stay aligned with your risk tolerance.
The Bottom Line for Retirement Investors
Target date funds and model portfolios both simplify retirement investing by diversifying your money and managing your retirement portfolio for you.
Choosing between a target date fund and a model portfolio comes down to how much customization and transparency you want and what may be available in your 401(k) plan. Target date funds follow a preset path tied to a retirement year, but can come with unexpected costs and risk. Model portfolios give you a clearer view of risk, time horizon fit, and a strategy that reflects your goals, but require occasional oversight.
Both can help you build long-term wealth, and both have their own strengths and drawbacks. If you are unsure which direction makes the most sense, our retirement experts can help walk you through your options.