What Drives Partial Users of TDFs?

Many research studies have shown how little investors actually understand about target date funds, and how few use them as the single solution they were designed to be. If “full use” of TDFs is optimal, what’s behind the partial use of them by so many participants?

About two-thirds of TDF investors are “partial users,” notes Lisa Greenwald of Greenwald & Associates, an independent research firm specializing in research for the retirement and financial services industries. “While it would be easy to dismiss them as just wrong, misunderstanding the purpose of TDFs or underestimating their value and why they should be used, the reasons for partial use are more nuanced than that,” Greenwald writes in her most recent column in NAPA Net the Magazine.

Even though a majority of partial users describe TDFs as diversified, “diversification” is the top reason they give for investing in other funds in addition to their TDF, Greenwald notes. “Sure, there are other forms of diversification, but given the financial literacy and sophistication of the average plan participant, I doubt they are all seeking fund manager diversity,” she writes. “To me, this means there is an opportunity for plan advisors to further educate on diversification and to meet with these participants to understand their reasons for partial use and develop an allocation that aligns with their goals and investment style.”

Perhaps even more compelling, partial users (and non-users too) suggest that TDFs do not match their risk tolerance, says Greenwald. Whether they want to be more conservative or more aggressive, many say TDFs are misaligned with their risk tolerance.

“Some plan participants are just control freaks,” says Greenwald, noting that non-users in particular say they don’t use TDFs because they prefer to select their own investments. Half of non-users and a third of partial users describe themselves as “do-it-myself” investors, while six in 10 full users are “do-it-for-me” types. Non-users’ version of do-it-for-me is delegating to an advisor, not an automatic investment, she notes.

“Seeking better performing funds was the second biggest reason for non-TDF use and was among the top five reasons for partial use,” says Greenwald, which mean that some non-users and partial users may be chasing investment performance rather than staying the course for the long term. She suggests that these participants’ accounts are ripe for review by a plan advisor, to ensure their tinkering is actually yielding an appropriate and effective allocation.

“While partial use of TDFs is an irrational misuse of the investment, the desire for greater diversification or for a more or less aggressive approach may be quite legitimate, especially if you factor in actual retirement plans, how non-plan assets are invested, and the participants’ general comfort level with investment risk. Greenwald asserts. “Understanding a participant’s attitude toward and use of TDFs may provide plan advisors with insight to help participants select a more custom, appropriate asset allocation.”

In addition to Greenwald’s regular “Inside the Generations” column, the summer issue of NAPA Net the Magazine includes the cover story profiling the winner of the 2016 NAPA 401(k) Advisor Leadership Award, as well as feature articles on the DOL’s final fiduciary rule and a wrapup of this year’s NAPA 401(k) Summit in Nashville. The issue also features insights from regular contributors Jerry Bramlett, Steff Chalk, Nevin Adams, David Levine, Brian Graff, Don Trone, Sam Brandwein, Fred Barstein and Warren Cormier.

To view Greenwald’s column, click here and select “TDFs: Misused and Mismatched on Risk Tolerance.” And to view a pdf of the full 64-page issue, click here.

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