Target-date funds (TDFs) offer a simple and automated approach to retirement savings for 401(k) participants, attracting a significant proportion of investor contributions to 401(k) plans.

As of 2023, TDFs constituted about 29% of assets in the average 401(k) plan, according to statistics from the Plan Sponsor Council of America, a trade association. This figure represents the largest portion of any fund category and has increased from 16% in 2014, based on PSCA data.

Cerulli Associates, a market research firm, predicted in 2023 that by 2027, TDFs will account for approximately 66% of all 401(k) contributions, and about 46% of total 401(k) assets will be invested in TDFs.

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The widespread use of TDFs is largely due to employers choosing them as the default investment option for employees automatically enrolled in their company 401(k) plans.

While TDFs offer advantages to many investors, financial advisors have highlighted potential downsides for others.

“TDFs can be beneficial for certain investors, but they certainly aren’t and shouldn’t be used universally,” commented Winnie Sun, managing partner of Sun Group Wealth Partners, based in Irvine, California, and a member of CNBC’s Financial Advisor Council.

Generally, financial experts advise investors to adopt a more conservative investment strategy as they age — usually by transitioning from riskier and more volatile assets such as stocks to more stable ones like bonds and cash.

TDFs automate this process, adjusting their investment strategy based on an investor’s projected retirement year.

For instance, a 35-year-old investor planning to retire in 30 years would likely opt for a 2055 fund. A 55-year-old may select a 2035 fund. These funds are usually available in five-year increments.

The allocation of a fund’s assets gradually shifts towards a more conservative approach in the years leading up to and sometimes following the retirement year.

Many praise TDFs for their simplicity, viewing them as an all-in-one solution for 401(k) savers who may lack the time or knowledge to effectively manage a custom portfolio.

“From my perspective, TDFs represent the most significant advancement for investors since the introduction of the index fund,” wrote Christine Benz, Director of Personal Finance and Retirement Planning at Morningstar, in June.

They remove crucial decisions such as asset allocation and investment selection from investors’ hands, Benz wrote.

TDFs provide affordable and sensible investment advice for individuals who may not have the means to hire an advisor or who might make erratic investment decisions, she wrote. TDFs also discourage behavior known to undermine investor returns, like buying high and selling low, she added.

“They’re designed to be easier-to-manage investments for those who favor simplicity and convenience,” Sun noted.

However, TDFs may not be suitable for all investors, especially those with substantial savings outside their 401(k) plan or who prefer a more active investment approach, advisors warn.

For instance, not all investors planning to retire at around the same age will have the same asset allocation requirements.

“What if you’re more conservative or prefer more growth-oriented, aggressive tech investing, or wish to invest in socially responsible investments?” Sun queried.

Asset managers have different investment philosophies. For example, certain fund families may adopt a more aggressive or conservative approach.

Employers usually only offer TDFs from one financial institution, and the funds available may not correspond with an investor’s risk profile, experts advise.

“It’s important for individuals to understand the level of risk associated with their target-date fund,” stressed Carolyn McClanahan, a Certified Financial Planner and the founder of Life Planning Partners in Jacksonville, Florida.

“For example, you might assume a 2030 target-date fund would adopt a conservative allocation, but most are 60% equities because they anticipate you’ll be relying on those funds over an extended period,” McClanahan, a member of CNBC’s Advisor Council, explained.

Investors may be able to create a less expensive portfolio independently using a combination of index funds, although this approach would require more effort on the part of investors, she suggested.

Furthermore, TDFs don’t accommodate “tax location” of different assets, McClanahan pointed out.

This strategy aims to enhance after-tax investment returns by strategically placing stocks and bonds in specific account types.

For instance, assets with high growth potential are ideally suited to Roth accounts, since investment earnings are generally tax-free in retirement, McClanahan advised.

Many experts also recommend holding a significant number of bonds and bond funds in tax-deferred or tax-exempt accounts.

Despite potential disadvantages for certain investors, “do TDFs assist investors unfamiliar with the basics of investing in achieving a sensible investment mix for their life stage?” Benz asked. “Absolutely, without a doubt.”