The idea behind target-date retirement funds is to keep things simple by providing an optimal asset allocation, given an investor's age, in just one fund. The fund automatically rebalances an individual's account to a more conservative mix of asset classes as he or she nears the target retirement date.

But a new study suggests that many retirement savers don't get it: they're holding a target date fund as just one of many funds in their 401(k)s. As a result, they're skewing their asset allocations and may be taking on more or less risk than appropriate or than they realize, says Youngkyun Park, a research associate at the Employee Benefit Research Institute (EBRI) in

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Washington, D.C. and author of a new study "Investment Behavior of Target-Date Fund Users Having Other Funds in 401(k) Plan Accounts."

Whether savers understand target-date funds is an important question since their use is growing with the encouragement of the U.S. Department of Labor, which has approved them as a "qualified default investment alternative" for retirement plans. That means if workers don't actively decide where to put their 401(k) contributions, the money could end up in target-date funds by default.
Moreover, the big names in mutual funds - Alliance Bernstein, Fidelity Investments, Oppenheimer, T. Rowe Price and the Vanguard Group - have all jumped on the target-date bandwagon. Typically, a fund is a blend of funds from the sponsoring firm.

In 2006, target date funds were held in 19% of all workers' retirement accounts and made up just 5.3% of all assets in the plans; by 2008, they were held by 31% of folks and accounted for 7% of assets, according to EBRI.

In his study, Park analyzed data from 759,314 investors in 13,815 different 401(k) plans who held target-date funds in their 401(k)s in 2008. All had balances between $10,000 and $250,000 as of year-end 2008."Pure" target-date fund investors, meaning they hold at least 99% of retirement dollars in one or more target date funds, don't have to worry about readjusting their asset allocation. They tend to be younger or lower-salary participants who are automatically enrolled in the funds. Some may split assets among more than one target date fund because they are unsure when they will retire.

But 55% of savers holding target-date funds also hold other funds as well. Nearly half of these savers hold 25% or less of their accounts in the target-date funds, and they mainly combine equity funds with target-date funds, the EBRI study found.

That pattern may in some cases reflect a conscious decision to own a higher-risk, high-equity portfolio, Park says. (Although Park didn't study it, it might also, in a minority of cases, reflect a desire to diversify among providers - say with a target-date fund from Fidelity and an equity fund from Goldman Sachs, assuming a 401(k) offers both choices.)

But the more likely explanation, Park's research suggests, is that investors misconstrue target-date funds as a substitute for stable value funds or money market funds, which provide safety, albeit low returns.

In fact, depending on a saver's age, a target-date fund can have substantial stock exposure - meaning if retirees are using these funds in place of money market funds, they're more exposed to stock market risk than they realize. A target date fund for someone planning to retire in 2040 might already have 72% to 97% in equities.

In his report, Park cites two recent surveys by AllianceBernstein and Janus Capital Group that support the explanation that investors don't understand what target-date funds are supposed to do. In both surveys, a majority of folks (58% and 63% respectively) who held target-date funds in combination with other funds explained they did so to diversify.

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