|A Set-It-and-Forget-It Retirement? Not Exactly… Financial Engines Study Shows Wide Misuse of Target-Date Funds Driven by Investor Overconfidence and Desire for Greater Diversification|
According to the report (“Not So Simple: Why Target-Date Funds Are
Widely Misused by
“While the ‘set it and forget it’ promise of target-date funds is
appealing to some investors, most participants don’t forget it -- they
are actively investing away from the target-date fund in their
Overconfidence in Investing Ability Can Harm Performance
Partial target-date fund users analyzed in the report tended to be older and overconfident in their investing ability. Sixty percent of partial target-date fund users believed that they could “beat the market” to achieve better investment returns than their target-date fund. Past studies have shown that a “partial target-date fund” approach can result in 2.11 percent lower median annual returns, net of fees, than holding all or almost all of an investor’s retirement assets in target-date funds.3
According to the report, participants who have added other funds to their target-date fund had greater confidence in how their accounts were invested compared to those fully invested in target-date funds. By mixing target-date funds with other investments, many participants fail to reap the full benefits of diversified, age-appropriate portfolios.
Ironically, only 23 percent of those fully invested in target-date funds were “very confident” that their assets were appropriately invested compared to 29 percent of those holding only part of their investments in target-date funds and 34 percent of those not invested in target-date funds at all.
“Prior to this research, it was easy to assume that participants didn’t fully understand how target-date funds worked,” explained Jones. “This research suggests that the drivers behind participant investing behavior are more complex than a simple lack of investing education. Older participants with higher balances require other forms of retirement help that more fully address what they are trying to achieve.”
A Fear of Putting All Eggs in
While target-date funds are designed for participants to invest all of their retirement assets in a single, age-appropriate fund, 62 percent of partial target-date fund users cited a desire for greater diversification and a fear of “putting all of their eggs in one basket,” as the primary reasons for moving money away from target-date funds. More than basic investment diversification, these partial target-date fund users were seeking additional diversification across both investment funds and asset managers. Fifty-four percent cited a desire for greater personalization, especially with regard to risk, while 58 percent of those decreasing their target-date fund allocation wanted greater personal management and advice on how best to manage their retirement assets.
“Target-date funds tend to work well for younger investors with low asset balances and less-complicated financial lives, while older participants with more assets often seek the greater personalization and access to investing professionals that managed accounts provide,” explained Jones. “Target-date funds only address the needs of a minority of participants. With a better understanding of how participants actually use target-date funds, plan sponsors have an opportunity to offer other forms of help that meet the needs of investors who are uncomfortable investing their entire retirement nest egg in a target-date fund.”
To download a copy of the report, visit https://corp.financialengines.com/employers/resources.html.
For more information, please visit www.financialengines.com.
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1 Help in Defined Contribution Plans, 2006-1012,
2 For independence methodology and ranking, see InvestmentNews Center (http://data.investmentnews.com/ria/).