TDFs Popular Among Retirement Plans, but Not as Default

Investor still suffer misconceptions about TDFs, AllianceBernstein says

Target-date funds are increasingly more common in defined contribution plans, but few plan sponsors have adopted them as their default investment option for participants, AllianceBernstein found in a survey released Tuesday.

While more than half of plan sponsors offer TDFs, the report found, of those, just half use them as the default investment when automatically enrolling participants.

AllianceBernstein surveyed more than 1,000 plan sponsors in November 2011 for the sponsor portion of the survey. It surveyed more than 1,000 participants in February 2012 for the participant portion.

“Even in the wake of a continuing decline of Social Security and defined benefit plans as primary sources for retirement income, our recent research shows that many plan sponsors are still struggling to find the best way to structure their DC plans,” Joe Healy, head of AllianceBernstein’s Defined Contribution Client Experience, said in a statement. “While more and more sponsors recognize the benefits of offering an age-based, asset-allocation investment solution to their participants, they fail to realize valuable fiduciary protections by not designating these funds as their plan’s default.”

Of the sponsors who don’t use a TDF as their default, 83% have no default at all, or are using a fund that isn’t a qualified default investment alternative, like a stable value fund, equity fund or bond fund.

While sponsors have largely accepted TDFs as a staple in their plans, they haven’t fully embraced their capabilities, the report found. About one in five midsize plan sponsors (those with between $1 million and $249 million in assets) and 22% of large sponsors (those with $250 million or more) offer a customized TDF.

Creating savings and increasing participation were the main goals sponsors had for TDFs. The report found large and midsize plans were more likely than small plans to say creating lasting savings for participants was their goal in adopting TDFs. Plan sponsors with less than $1 million said their goal in adopting TDFs was to ensure a minimum level of savings for participants. Midsized plans were most likely to say they adopted TDFs to help increase participation, despite small plans having the lowest participation rates.

In its participant survey, AllianceBernstein found 38% are considered “active” investors: They started saving early, actively manage their investments or work with a manager who does so and are confident about their financial situation. Nearly two-thirds, though, are “accidental” investors. They are apathetic about investing and lack confidence in their abilities. They are less likely to use TDFs, and while those who use TDFs report high levels of satisfaction (72%), they are still less likely than active investors to be happy with them.

“It’s striking that despite the almost polar opposite behavioral differences between active and accidental investors, both groups give TDFs high marks,” Healy said. “It certainly suggests that sponsors can stave off behavioral biases and encourage savings by defaulting people into easy-to-understand investment solutions like TDFs that also provide sophisticated asset-allocation features to satisfy savvy investors.”

The report found that some participants may be misinformed on some of the benefits of TDFs that could affect their ability to be prepared for retirement. Over one-third of participants incorrectly believe their TDF balance is guaranteed to never go down and 23% weren’t sure. Thirty-seven percent believe having a TDF is a guarantee that their income needs will be met and 22% weren’t sure. The report attributed these misconceptions as a result of “amateur” investors’ inexperience with investing: “It’s tough enough doing our day jobs, and most participants lack the time, motivation or skill to become investment experts.”

That may seem to suggest more education is in order, but the report found many sponsors believe their communications are ineffective. The report asked participants whether it was true that TDFs get more conservative as investors get closer to retirement. Two-thirds answered correctly, but 20% said they didn’t know. That such a large percentage of participants were unwilling to answer a true-or-false question about a subject commonly found in fund literature suggests more education may not necessarily lead to better understanding, according to the report.

“While participants continue to have misconceptions about certain TDF features, our research suggests that it’s unclear whether more education is the solution,” Healy said. “The reality is that accidental investors often don’t want to understand how investments work—they just want to know they do work.”

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