Do-it-yourself retirement plan participants tend to be less diversified than those who participate in target-date funds. The Principal Financial Group looked at 2.4 million defined contribution plan participant accounts to see how the do-it-myself investors compared to TDF investors.
The research found that generally, do-it-myself participants were less diversified by asset class and number of investment options, rarely using automatic rebalancing to meet their investment goals, and at younger ages, frequently had much less exposure to equities.
Do-it-myself participants used an average of two to four investment options across the board, compared to the average 15 to 20 underlying investment options, representing a variety of asset classes, within the typical target date portfolios, the report found.
“It’s clear that left to their own devices, participants often don’t fully understand the importance of diversification,” said Jeff Tyler, portfolio manager, Principal LifeTime Funds. “We believe a minimum of five asset classes should be used with a broad selection of investment options to provide adequate diversification for the typical retirement plan participant. The research shows that many do-it-myself investors aren’t meeting that mark. While asset allocation doesn’t assure a profit, target date portfolios seek to accomplish this goal by providing access to multiple underlying investment options and investment managers within a single investment option.”
According to the research, the average do-it-myself participant born after 1987 had nearly 30 percentage points lower equity exposure within their investment portfolio compared to the nearly 84 percent within a target date investment option.
“Younger investors have a longer time horizon for investing with opportunity to ride out the fluctuations in the market– and therefore a higher tolerance for the risks that come with exposure to equities in their investment portfolios,” said Tyler. “Taking advantage of compounded earnings from a young age is a potential driver to a financially successful retirement.”
Only 2 percent of do-it-myself investors took advantage of an automatic rebalancing service. Most TDFs have auto-rebalancing built into their investment options.
“We found that do-it-myself investors are rarely taking the important step of selecting auto- rebalancing services to keep their portfolios at the risk tolerance level they selected based on their time horizon. Auto -rebalancing is another step to take the emotion out of investing, to avoid negatively reacting to volatile markets,” said Tyler.
The Principal Financial Group is a global investment management company that provides retirement services, insurance solutions and asset management.