A recent study conducted by Financial Engines and Aon Hewitt, “Help in Defined Contribution Plans: 2006 Through 2012,” explores the impact of using “help.” The study, which was noted in a May 20 NAPA Net post here, investigated the use of help in 14 DC plans — covering 723,000 participants with more than $55 billion in plan assets.
The study defines “help” as either having more than 95% of DC investor assets in two or fewer target date funds (TDFs), 100% of assets in a managed account or utilizing online advice.
As one would suspect, those utilizing help had higher overall returns than those who did not. According to the study, the annual performance gap between the median returns of “Help Participants” and “Non-Help Participants” was 3.32%, net of fees over the period 2006–2012. Putting this return difference in perspective, the report states that, “for a 45-year-old Help Participant it could translate to 79% more wealth at age 65.”
Regarding the return difference between managed account users and TDF users, “as expected there was only a modest difference in median annual returns, with managed account portfolios outperforming target-date fund portfolios by 0.50% (50 basis points), net of fees,” the study found. It is important to note that in this return comparison, investors with 95% of their assets in one or two target date funds were compared with those investors with 100% of their assets in a managed account program. For there to be a true apples-to-apples comparison, participants with 100% in a single TDF should be compared with those with 100% in a managed account. Presumably, if this comparison was made in this fashion, the “modest difference” in return may disappear altogether or TDFs could even be higher. That is to say that neither managed accounts or TDFs seem to have a return advantage over the other.
One of the main themes the study drives home is that participants are sabotaging the help TDFs give them. This refers to the extensive treatment that the study gives to “partial target-date fund usage” — defined as participants with less than 95% of their assets in no more than two TDFs. In fact, the study reports, “the majority of partial target-date fund participants were using target-date funds in a manner very different from the funds’ intended design” (i.e., an all-in-one investment).
To take the position that DC investors are “sabotaging” the help they are being offered because they invest less than 95% of their assets in more than two TDFs, seems to be off base. It implies that DC investors, for some reason or another, are choosing to harm themselves. The fact is that blame for the real sabotage, as it relates to TDF adoption rates, ought to be placed clearly on the shoulders of the communication framework. This tendency on the part of DC investors to not use TDFs based on their “intended design” is not a systemic issue related to TDFs as an asset allocation construct.
Employee communication programs that do not allow DC investors to invest in multiple TDF strategies by definition have no partial TDF investors. With a single stroke of the plan design pen, this problem — which seems to plague the proper use of TDFs — is gone. Some may say that this seems unfair for the occasional participant who actually has thought it all through and has a strategic reason for using multiple TDFs to be restricted in this manner. If this study is correct — that a 45-year-old “help” investor (which excludes partial TDF investors) have excess returns that “could translate to 79% more wealth at age 65,” then what is the more prudent approach? Make allowances for the rare participant who will invest in more than one TDF once they truly understand its “intended use,” or ensure that all TDF investors get it right and, thus, have the potential to achieve dramatically better outcomes?
Conclusion
Managed accounts and target date funds, at least in this study, have similar returns. What is different is how each asset allocation program is adopted.
When a DC investor uses a managed account program, an all-in-one-investment strategy automatically flows from that choice. Because TDFs are funds that are typically cast alongside other investments — including single asset class funds — they create a decision structure that practically invites participants to “diversify.” In fact, isn't that what is drummed into DC investors' heads — the need for greater diversification?
The answer to the partial-TDF investment conundrum is not more education about TDFs. Education as to what a TDF has as its “intended use” is everywhere in communication literature. What is required is a structural change in how DC investors invest in TDFs. Until that happens, we will continue to receive bleak news on TDF adoption — and hear about how TDF investors are “sabotaging” themselves.
