A new report by Alight Solutions, LLC reveals some eye-opening findings about how some 2.5 million target-date fund investors are saving – and investing.
The report, titled five surprising facts about target-date funds, winds up being a report perhaps more aptly titled “five surprising facts about target-date fund INVESTORS.” Here’s what stood out to me.
People Who Use Target Dates Save Less
Perhaps the biggest eye-opener in this report is that people who use target-date funds contribute less than those who don’t. Now, you may be thinking that it’s a function of participants who are not only defaulted into TDFs, but who are defaulted in at lower rate of deferral than those who make active enrollment decisions. Well, that’s (still) a reality in many cases, but Alight says that the disparity in savings rates applies even when accounting for factors like age (generally speaking, younger workers contribute less) and automatic enrollment (generally speaking, the default deferral rates are less than what participants elect voluntarily).
In fact, on average, full TDF investors contribute 6.2%, compared to 8.4% for other investors, according to the report. For those automatically enrolled, TDFers contributed 5.3% (on average), compared with 7.6%. For those under age 30, TDFers deferred 5.6% (on average) compared with 7.7% for those who forego that option (and 7.5% who are partial TDF users).
People Who Use TDFs Don’t Stay with Them
One of the great challenges of participant self-direction is that, even those who take the time to make investment allocations tend not to (ever) revisit those decisions. However, Alight found that fully half of those who invest fully in TDFs move out of that option within a decade. Now, in fairness, many of these folks are defaulted into that option, and so they perhaps don’t have the same tie to that investment decision as an individual who took the time to make that choice.
On the other hand, these investors aren’t exactly fleeing the choice; only 6% have “lapsed” from TDFs within a year, and even after five years, just 22% have.
The More Precise the Target-Dates, the More Likely the Utilization
This one is a bit of a head-scratcher, but the folks at alight that – at least among those with account balances greater than $50,000 – individuals are more likely to use TDFs when vintages are offered in increments of five years rather than 10 years (among those with balances under $50,000, there was also a difference, but Alight described it as “negligible”).
How much of a gap? Well, Alight found that 55% of those with balances above $500k invested in TDFs when there were five-year increments, while only 38% did when their choices were expressed only in 10-year increments (the numbers were 59% and 48%, respectively, among those with balances between $250,000 and $500,000).
Even When People Leave TDFs, They Don’t COMPLETELY Leave
Alight notes that, in 2018, when people switched from full TDF usage, three-fourths left at least some money in those investments. Now, it may be worth noting that some DID move fully away from TDFs, and that those were most likely to be close to retirement age. Specifically, more than one-third (36%) of people age 60 or older who changed from full TDF use chose not to use TDFs at all.
So, what do those who left TDFs do with their money – well, almost half (46%) invested their entire balance in equities (14% invested solely in fixed income). Younger workers were just as likely as older workers to choose an all-or-nothing equity strategy, but they were more likely to completely invest in equities. And lest you think that all those older workers were looking to get out of equities – 30% of investors age 60 or older chose a 100% equity allocation after changing from full TDF use, while 27% went for all fixed income.
All in all, older participants were least likely to have their entire balance invested in a TDF; among those age 60 or older, just 25% had their entire balance in a TDF.
The Greater the Number of Choices, the Less Likely TDFs
The report fins that TDF usage depends on what other investment funds are available – specifically, when there are more funds available, people are less likely to be invested in TDFs. While 44% of participants invested fully in TDFs when there were less than 12 fund choices available, when there were more than 25 options, just 17% of participants invested fully in TDFs.
Interestingly enough, Alight found “virtually no difference” in the percentage of people who invest in TDFs when company stock is available as an investment option in the 401(k) versus when it is isn’t available. However, partial TDF use was found to be higher in plans with company stock.
Unclear on the Concept
For years we’ve told participants of the importance of diversifying their investments – that they shouldn’t “put all their eggs in one basket.”
Well, it may not have seemed like it at the time, but numerous reports that indicate that a notable minority of TDF investors don’t really seem to grasp the concept of the single fund investment – that, rather than “leave all their eggs in that one basket,” they seem to feel the need to “diversify” that already diversified TDF investment.
The Alight report also noted that, among those investing in multiple TDFs (already a conceptual “disconnect”), one in three (33%) are invested in more than two “vintages.” But they aren’t exactly splitting the difference – only a third (34%) of those investing in multiple vintages use two vintages that are “consecutive.”
There’s little question that the target-date fund concept, writ large, has had a significantly positive impact on both the quality of diversity in American workers’ retirement savings, both initially, and on an ongoing basis as they are systematically reallocated.
That said, the Alight report suggests that education gaps remain in this powerful tool – and that participants, while they may well be better off, run a risk of misusing this strategy in a way that might do more harm than good – but may well be causing some harm.
