Investors Misfire With Target-Date Funds

By Ashlea Ebeling | December 17, 2009 AAA

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

Risks and Rewards On Target Date Funds

Fixing Your 401(k)

Do It Yourself Investing

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.

Related Articles
  1. Africa's economic growth and growing stability has gotten the attention of adventurous investors. What kind of ETF or mutual fund options are available?
    Mutual Funds & ETFs

    Destination Africa: These Funds Offer ...

  2. A Monte Carlo simulation allows analysts and advisors to convert investment chances into choices. The advantage of Monte Carlo is its ability to factor in a range of values for various inputs.
    Fundamental Analysis

    What Can The Monte Carlo Simulation ...

  3. A description of the top retirement plans for self-employed
    Retirement

    Self-Employed? Top Plans For Retirement ...

  4. Understanding how to save for retirement does not have to be complicated. Here’s what you need to know about the tax-advantaged accounts you may use.
    Retirement

    Want To Know How To Save For Retirement? ...

  5. Whether you're a saver or a financial advisor who want to give their clients a leg up, these 8 tips are essential for financial planning.
    Investing Basics

    8 Essential Tips For Retirement Saving

Trading Center