When they do pull savings from TDFs, investors oftenmake erratic allocations on their own. (Photo:Shutterstock)

Utilization of target-date funds, which are designed to get afunctional investment strategy to 401(k) savers who may not knowthe first thing about investing, is being hurt by what savers don'tknow about TDFs.

"There are a lot of participant misconceptions around TDFs—59percent say they don't know anything about them," said Rob Austin,vice president and head of research at Alight Solutions and authorof new research showing many TDF investors are enlisting the "wrongbehavior" with their set-it-and-forget-it investments.

Consider this: Half of TDF investors end up pulling money out ofthe funds after 10 years, yet the investments are designed to bringa saver either to or through retirement. Nearly a quarter pulltheir savings after 5 years in a fund, and 15 percent do after 3years.

When they do pull savings from TDFs, investors often makeerratic allocations on their own. Over the last 2 years,three-quarters of those that dropped TDFs increased the equityallocations in their portfolios.

For those ages 60 and over that pulled money from TDFs, 59percent increased their equity exposure. And 30 percent in thatgroup shifted to an all-equity portfolio.

Perhaps some level of individual investor sophisticationexplains why they move out of TDFs to design their own portfolio.But a level of fundamental misunderstanding of TDFs is also alikely reason, says Austin.

"We don't know exactly why money is being pulled out of thefunds," he said. "But if you know nothing about investing, onething you have heard is 'don't put all of your eggs in onebasket'.

Unfortunately, most of the respondents Alight questioned don'tknow that a TDF isn't "one basket."

Only 14 percent of participants questioned in a separate studycorrectly said that TDFs rebalance allocations over time. Only 11percent correctly said TDFs are designed so that one fund can beinvested in as opposed to several.

"To a lot of people, a single TDF looks like one basket—theyopen up their statements, see one fund, maybe panic a bit becauseall they see is one investment, and then they try to diversify,"explained Austin.

TDF investors have lower contribution rates

Participants fully invested in one TDF have lower contributionrates than partial TDF investors or non-TDF users.

For instance, the average near-retiree full TDF investor has anaverage contribution rate of 7.6 percent, compared to 11 percentfor near retirees that invest on their own.

Low default rates don't fully explain that spread, said Austin,as lower contribution rates are seen when TDF investorsself-enroll.

"Even if you pick your own TDF, you tend to be saving at a lowerrate," he said. "It could be explained, in part, by investmentsophistication. TDF users don't really understand TDFs. Do theythen understand how much they need to save?"

Alight pulled data on 2.5 million TDF investors—all accounts arerecord kept by Alight, which serves the large and jumbo planmarket.

That begs a question: Why are large sponsors with ostensibly thebest communication resources failing to educate investors on thebasics of TDFs?

"There's always going to be a difference between what peoplehear from messaging and what they act on," said Austin. "It's notas if sponsors' communication efforts are falling on completelydeaf ears. But inertia is a tough power to overcome. It's not easyto get people to change how they save."

In extreme cases, sponsors take a paternalistic approach anddon't allow participants to partially invest in a TDF. Or, morecommonly, employers will re-enroll partial TDF investors fully intoa qualified default TDF, letting savers opt out if they take theinitiative to do so.

"We're seeing about 10 percent of sponsors use re-enrollment tomake sure TDFs are being used they way they were intended," saidAustin.

While 401(k) investing is ultimately self-directed investing,there is still more that can be done to bridge the gap between howTDFs are intended to be used and how many savers use them, saidAustin.

"There's a disconnect between how companies are communicatinginvestment strategy, and how participants are interpreting it andacting upon it," he added.

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