Target Date Fund Users Need Guidance
Target date funds (TDFs) are a popular option for many retirement plan investors. According to Vanguard’s How America Saves 2019 report, more than half of all retirement plan participants are invested in a single target-date fund while 77% of participants use at least one. It’s no wonder that nine out of 10 plan sponsors were offering a target date fund at year-end 2018, per the Vanguard report.
Target date funds are designed to simplify retirement investing for plan participants. Most target date funds offer a pre-determined mix of investments that automatically shift the asset allocation as an investor approaches retirement. Typically, target-date funds start out with a heavy allocation in stocks, then as the participant ages, the investment allocation shifts gradually through rebalancing until it results in a large weighting of less risky investments, like bonds. A key benefit of target-date funds is they are largely hands-off — investors can “set it and forget it.”
However, target-date funds may not be the total retirement investing panacea they have appeared to be in the past. In fact, benefits solutions provider Alight Solutions recently released a white paper titled “Five surprising facts about target-date funds,” which found that the way retirement plan participants are using these investments may actually be detrimental to their retirement readiness. Alight Solutions studied the savings behaviors of approximately 2.5 million target-date investors.
Here are the five surprising facts Alight Solutions highlighted about participants’ use of target-date funds:
- Participants who use target date funds contribute less to their retirement accounts than those who don’t. Alight found that even when accounting for factors such as age and automatic enrollment (which might cause a participant to be defaulted into the plan at a lower contribution rate), participants who fully invest in target date funds tend to save less than others. On average, investors who were fully invested in target date funds contributed 6.2% to the plan vs. 8.4% for other investors.
However, among investors who changed from full target date fund use, nearly half (47%) actively changed their contribution rate. Of those, 14% changed their contribution rate via automatic escalation and the remaining investors kept their contribution rate the same. Those who changed their contribution rate typically increased it. Those who changed from being fully invested in target date funds raised their contribution rate to an average 10.5%.
- People don’t stay invested in target date funds for their entire career. Nearly half (49%) of participants who were invested in target date funds moved out of them within 10 years. Those who are actively employed are much more likely to change from being fully invested in a target date fund. Alight Solutions also discovered, participants who voluntarily enrolled in their workplace retirement plan were more likely to move out of target date funds than those who were automatically enrolled or used “quick enrollment” — a process by which an employee makes a quick election to join the plan online or by mail using a pre-selected savings rate and investment allocation.
- Target date fund uptake is affected by the availability of other investment funds. When companies offer more funds outside of target date funds, participants are less likely to use the Target Date Funds as intended. In addition, the more funds that are available in the plan, the less likely participants are to invest in target date funds. In plans with less than 12 funds, 81% of participants engage in full or partial target date fund usage. In plans with more than 25 funds, that figure declines to 50%.
- When participants move out of target date funds, they make extreme changes to their investment allocation. Many participants increased their overall portfolio allocation to stocks when they moved out of target date funds, Alight found. Among participants who stopped using target date funds altogether, nearly half (46%) invested their entire portfolio in stocks; 14% invested fully in fixed income.
- It’s common for participants to invest in multiple target date funds. One out of every 10 retirement plan participants who use target date funds is invested in more than one vintage. Those with larger balances are more likely to invest in more than one vintage. Among those fully invested in target date funds with a balance of at least $100,000, 9% used more than one target date fund vintage.
While target date fund usage is prevalent among retirement plan participants, these five factors indicate that they don’t have a good handle on how these investments work and how they should be used. Alight’s findings bear this out: 59% of participants it surveyed indicated they knew nothing about target date funds. Moreover, just 14% correctly indicated that a target date fund rebalances over time, and only 11% correctly responded that a target date fund is designed so people only need to invest in one fund rather than several.
As such, plan sponsors should consider how to better educate retirement plan participants on the proper usage of target date funds when saving for the future. In addition, sponsors might also ask, are there better options available for the plan than target date funds? If participants are moving out of target date funds and into stocks, how can plan sponsors ensure that they are selecting the right allocation for their situation? These are all important questions plan sponsors need to answer to help participants to effectively use the investments offered in the plan to achieve retirement security.