Target Date Funds vs. Index Funds: Which Is Better?

Target-date funds and index funds are two of the most common investment choices for retirement savers seeking a low-maintenance, long-term strategy. Both options offer broad diversification and are designed to simplify the investment process, making them ideal for those who prefer a hands-off approach. Target-date funds, in particular, have surged in popularity following their approval for use in defined contribution plans like 401(k)s. But while both fund types are considered convenient and efficient, they serve different purposes and follow distinct investment strategies.

Consider speaking with a financial advisor for help aligning your investment strategy with your long-term goals.

What Are Target-Date Funds, and How Do They Work?

Target-date funds (TDFs) are mutual funds or exchange-traded funds (ETFs) designed to simplify long-term investing, particularly for retirement. They operate as “funds of funds,” meaning they invest in a mix of other mutual funds to create a diversified portfolio within a single investment. A typical TDF might include asset classes such as stock funds, bond funds, and money market or alternative investment funds, depending on the fund’s goals and risk profile.

Built-In Asset Allocation

What sets target-date funds apart is that they adjust their asset allocation over time based on a specific target date, usually the investor’s anticipated retirement year. For example:

A 2065 target-date fund will hold a more aggressive mix of investments, often allocating up to 90% of the fund to equities to maximize growth over a long time horizon.
A 2035 fund, on the other hand, will lean more conservative, prioritizing capital preservation and income generation by shifting a larger percentage into bonds and other fixed-income investments.

As the target year approaches, the fund automatically rebalances its holdings, gradually shifting from a growth-oriented strategy to a more conservative, income-focused one. This glide path reduces the investor’s risk exposure as they near retirement.

Benefits of Target-Date Funds

Target-date funds are popular for their hands-off approach. Once you choose a fund that aligns with your retirement year, you don’t have to worry about rebalancing or making allocation decisions, the fund does it for you. This simplicity makes TDFs attractive to beginner investors or those who prefer not to actively manage their portfolios.

Key Considerations and Drawbacks

Despite their convenience, target-date funds aren’t without downsides. Fees are a major consideration:

Many TDFs carry layered costs, including both a management fee for the target-date fund and additional fees for the underlying mutual funds.
Actively managed TDFs tend to have higher expense ratios than passively managed ones.
According to Morningstar, the average asset-weighted expense ratio for TDFs at the end of 2024 was 0.29%, down from 0.52% in 2020.

Another issue is that not all TDFs are created equal. Different fund providers use different glide paths, asset mixes and fund selections, so it’s essential to review what’s under the hood before investing.

Trends in Popularity

Target-date funds have grown significantly in popularity, particularly within employer-sponsored retirement plans. Assets under management totaled around $1.7 trillion in 2018, then slightly declined to $1.6 trillion by early 2021, before reaching a record $3.5 trillion in 2023.

What Are Index Funds, and How Do They Work?

Index funds are a type of mutual fund or ETF designed to mirror the performance of a specific market index, such as the S&P 500, Dow Jones Industrial Average or Nasdaq Composite. Instead of trying to beat the market, these funds aim to match the performance of the index they track by holding the same (or a representative sample of) securities in similar proportions.

Passive Management and Cost Efficiency

One of the defining features of index funds is that they are passively managed. Fund managers don’t need to actively research or select individual stocks, which leads to lower operating costs. As a result, index funds generally have lower expense ratios than actively managed funds, often around 0.2% or less. Many index ETFs have even lower fees and can be purchased with minimal initial investment, sometimes as low as the price of a single share (typically ranging from $50 to a few hundred dollars).

Diversification and Market Exposure

Investing in index funds provides instant diversification across multiple sectors and companies. For example, an S&P 500 index fund gives investors exposure to 500 of the largest publicly traded U.S. companies, offering a snapshot of the broader market. However, most index funds are market-cap weighted, meaning that larger companies — like Apple, Microsoft and Amazon — make up a disproportionate share of the portfolio. This can create a concentration risk if one sector, such as technology, experiences a downturn.

Performance vs. Active Management

Historically, index funds have often outperformed actively managed funds, especially over the long term. This is largely due to their lower fees and consistent exposure to the broader market. According to SPIVA (S&P Indices Versus Active), many large-cap mutual funds have underperformed the S&P 500 over the past five years. While some active funds may beat the market in a given year, maintaining that performance consistently is rare. On average, about two-thirds of actively managed large-cap funds underperform their benchmarks over multi-year periods.

Growing Popularity Among Investors

Index funds have grown rapidly in popularity thanks to their simplicity, low cost and competitive returns. In 2018 alone, investors poured $458 billion into index funds, compared to $301 billion in actively managed funds. This shift reflected a growing preference for low-maintenance, cost-effective investment strategies that align with long-term financial goals, particularly among retirement savers. However, the market action in April 2025 saw $4 billion withdrawn from index funds, as investors fled to cash or other safe investments.

Comparison of Target-Date Funds vs. Index Funds

An investor compares the price action of target date funds vs. index funds.

Which is better for the investor, target-date funds or index funds? One thing is clear. Many investors prefer investment portfolios that they don’t have to actively manage themselves. Most investors in target-date funds may be new to investing and they may be more risk-averse than other investors. They prefer to leave the portfolio management to fund managers rather than attempting it themselves whether in an index fund or a target-date fund.

The three most important factors in evaluating target-date vs index funds are:

Time Horizon: A target-date fund is based on the investor’s time horizon. If your time horizon is 40 years from now, a target-date fund will develop a portfolio with an intent to grow during the early years and preserve wealth during later years. You can buy and hold a portfolio of index funds tracking different market indexes with different goals and it may perform as well as the market over the long term and perhaps better than comparable target-date funds.
Risk tolerance: Both target-date funds and index funds try to minimize risk. Index funds track a market index and the goal is to perform as well as the index. Target-date funds try to outperform the market unless they are target-date index funds. A problem with target-date funds is that buried in some of the mutual funds in a target-date fund may be riskier securities than the investor can tolerate. Examples are stock in companies that are in the emerging market, foreign bonds or junk bonds.
Tax efficiency: Many investors are in target-date funds because that is what their 401(k) offers. Since they are in a tax-advantaged investment, tax efficiency isn’t an issue until the target date. By the target date, the fund may be heavily invested in bonds. That isn’t a problem during the life of the fund, but after the target date, tax efficiency will decline. You can choose index funds for your portfolio and avoid some of the tax issues of target-date funds.

Target-Date Funds vs. Index Funds: Pros and Cons

When deciding between target-date funds and index funds, it’s important to weigh the strengths and weaknesses of each investment type. Both offer a streamlined, low-maintenance approach to building a diversified investment portfolio, making them popular choices for retirement savers and hands-off investors. However, they serve different purposes and come with distinct trade-offs in terms of cost, flexibility, performance and risk. Below is a breakdown of the key pros and cons to help you determine which option best aligns with your financial goals and investing style.

Pros of Target-Date Funds

Target-date funds are ideal for beginning investors or those who prefer a hands-off approach to retirement planning. These funds automatically adjust their asset allocation over time, becoming more conservative as the target retirement year approaches. This makes them appealing for people who want to “set it and forget it.”

Another key advantage is accessibility. Target-date funds typically have low minimum investment requirements, allowing investors to achieve diversification early on. They’re also professionally managed, meaning investors benefit from the oversight of experienced fund managers who rebalance the portfolio over time to maintain the fund’s glide path.

Cons of Target-Date Funds

Despite their appeal, target-date funds have limitations. Most are built using mutual funds from a single fund family, such as Vanguard or Fidelity, which may restrict diversification opportunities. Fees can also be a drawback. While some target-date funds are competitively priced, others layer management fees on top of the underlying fund expense ratios, potentially eroding returns over time.

Another concern is that some target-date funds stop adjusting asset allocation after the target date, which could leave retirees exposed to unnecessary risk. These funds also don’t take into account outside sources of retirement income, which may misalign their built-in allocation with your actual financial needs. Historically, many target-date funds have underperformed market benchmarks, especially compared to low-cost index funds.

Pros of Index Funds

Index funds appeal to investors seeking a low-cost, low-maintenance way to match market performance. Because they’re passively managed, they typically carry very low expense ratios and no management fees. This cost efficiency, combined with minimal trading activity, also helps reduce tax exposure.

Long-term investors benefit from the steady, reliable growth of index funds, as they tend to track the overall performance of major market indexes like the S&P 500. Additionally, they offer broad portfolio diversification, often spanning hundreds of companies across sectors and industries.

Cons of Index Funds

The primary limitation of index funds is their inability to outperform the market. Investors are essentially signing up for average returns — nothing more, nothing less. During strong bull markets, this may seem like a missed opportunity compared to actively managed funds that outperform benchmarks.

Index funds can also be vulnerable to market volatility. Since they track specific indexes, they offer no protection from downturns in those markets. Finally, they lack flexibility by design; an index fund must follow its benchmark closely, which limits the fund manager’s ability to adapt to changing conditions or identify unique opportunities

Bottom Line

An woman compares target date funds vs. index funds.

Investors in either type of mutual fund or ETF seek professional management, a hands-off approach and don’t want to be bothered with retirement planning. Index funds outperform most actively managed target-date funds. They are good for investors who are risk-averse and have a long time horizon. Target-date funds may be tax-advantaged, however, since they are approved for inclusion in 401(k)s. However, they require an investor to stick with one fund family. Target-date funds have been subject to much criticism since their development. Their asset allocation and investment strategy have been questioned, along with their high fees as compared to index funds.

Tips for Investing

If you need help choosing between a target fund or index fund, or are interested in incorporating both into your strategy, consider working with a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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