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

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

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

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

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

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

"We don't know exactly why money is being pulled out of the funds," he said. "But if you know nothing about investing, one thing you have heard is 'don't put all of your eggs in one basket'.

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

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

"To a lot of people, a single TDF looks like one basket—they open up their statements, see one fund, maybe panic a bit because all 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 contribution rates than partial TDF investors or non-TDF users.

For instance, the average near-retiree full TDF investor has an average contribution rate of 7.6 percent, compared to 11 percent for 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 investors self-enroll.

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

Alight pulled data on 2.5 million TDF investors—all accounts are record kept by Alight, which serves the large and jumbo plan market.

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

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

In extreme cases, sponsors take a paternalistic approach and don't allow participants to partially invest in a TDF. Or, more commonly, employers will re-enroll partial TDF investors fully into a qualified default TDF, letting savers opt out if they take the initiative to do so.

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

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

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

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Too many retirement investors not using TDFs as they are intended

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