Many retirement investors are not using target-date funds as intended, and may be losing out on thousands of dollars in returns, according to a study by Financial Engines and Aon Hewitt.
The study, “Help in Defined Contribution Plans: 2006 through 2012,” examined the 401(k) investing behavior of roughly 725,000 workers at 14 large U.S. employers.
It found that more than 60 percent of workers who hold money in target-date funds also invest in other funds, and among that group the average allocation to target-date funds was just 35 percent. The funds are based on the investor’s target retirement date and invest accordingly in a mix of stocks, bonds and cash with age-appropriate risk.
“Target-date funds play an essential role in a well-designed 401(k) plan and can be a cost-effective, all-in-one solution for participants with simple needs. However, when employees fail to invest in them exclusively, they often end up undermining the benefits of these funds, which are controlling risk and providing good diversification,” said Wei-Yin Hu, vice president of financial research at Financial Engines.
Indeed, the study found that on average, workers who were partially allocated to target-date funds had median annual returns that were 2.11 percent lower than those who allocated all of their investment to target-date funds and 2.61 percent lower than those in managed accounts.
“Improper use occurs for a variety of reasons, including an employer matching in company stock, workers attempting to time the market, or a lack of understanding of how target-date funds work. Participants may also simply be averse to putting all of their money in one fund as their balance grows,” said Hu.
“Companies that have automatic enrollment should determine if workers are using the plan appropriately, and if not, make adjustments such as educating participants about proper diversification.”