Target date funds, which have become default investments for defined contribution retirement plans, accounting for one-quarter of their total assets and 40% of new contributions, may not deserve their growing popularity.
A new report from Alight Solutions, a recordkeeper for 401(k) plans, found that plan participants investing in TDFs exclusively or partially save less than participants who don’t invest in TDFs because they contribute less.
On average, participants who invest exclusively in TDFs contribute 2.2 percentage points less than other investors: 6.2% versus 8.4%, according to the Alight Solutions report, which is based on the behavior of approximately 2.5 million TDF investors as of Jan. 1, 2019. Total assets of TDFs were $1.10 trillion at year-end 2018 with DC funds accounting for two-thirds of those assets, according to ICI and Morningstar.
“Target date funds are better than money market and stable value as default investments [which had prevailed previously] but they may not be the perfect investment,” says Rob Austin, Vice president and head of research at Alight, which was spun off from Aon Hewitt in 2017 sale to the Blackstone Group.
The study isolated the two variables that were thought to be the reasons behind the lower contributions by TDF investors — more younger investors who tend to save less than older investors and more auto-enrolled investors who tend to remain at the usually low preset contribution rate. “But even when those variables were taken out of the equation people were still saving less,” says Austin.
“There is something inherent in TDFs that has people using them saving less … But whether there’s a flaw in the people or product, we don’t know,” says Austin. He couldn’t identify that inherent factor and suggested instead further study of TDFs and their contribution rates. In addition, Austin suggested that TDFs become more sophisticated, adding variables beyond age to set allocations.
Now TDFs operate as if “everyone in the same age bracket has same investment outlook, attitudes and needs. Maybe that’s painting with too broad a brush,” says Austin. He suggested that funds consider asking whether participants have a spouse or a pension or other assets outside their 401(k) or about how long they’ve been with a particular company. “I would like to see more evolution in TDFs, than just birthdate, not complete overhaul but more innovation in the TDF space.”
The Alight Solutions study also found other unexpected results among investors using TDFs:
- Many participants investing in TDFs don’t remain invested in them for very long. Almost half of those fully invested in TDFs switched out within 10 years, and almost one-quarter left within five years.
- Among those who stopped using TDFs altogether, many chose extreme changes in asset allocations — 46% chose to invest exclusively in equities while 14% chose only fixed income.
- Ten percent of TDF investors invest in multiple TDFs.
- Many plan participants invest in a combination of one or more TDFs plus other investment funds when they are available, which is not the intended use of these funds.
TDFs are intended to be standalone, diversified investments for plan participants who don’t want to choose their own asset allocations and funds.
— Check out How to Stop 401(k) Participants From Taking the Money and Running on ThinkAdvisor.