A recent study by Financial Engines and Aon Hewitt says that target date funds work best if a plan participant invests all or nearly all of their retirement assets in them. Barrons also weighs in on the issue, quoting Bloomberg's Ben Steverman.
Steverman cites “Help in Defined Contribution Plans: 2006 through 2012,” a report that examined the 401(k) investment behavior of 723,000 employees at 14 large U.S. employers. Among the findings was that the higher the use of TDFs, the higher the annual returns.
The study says that the way a participant uses TDFs can affect retirement account growth. The study found that more than 60% of participants who hold money in TDFs also invest in other funds, and that the average allocation to TDFs was 35% of their retirement fund assets. It found that on the average, participants who partially allocated their assets to TDFS had 2.11% lower median annual returns than those who exclusively invested in TDFs.
And why do the participants who take that approach to TDFs do so? Financial Engines’ VP of Financial Research Wei-Yi Hu said in a press release, “Improper [TDF] use occurs for a variety of reasons, including an employer matching in company stock, workers attempting to time the market, or a lack of understanding of how target date funds work. Participants may also simply be averse to putting all of their money in one fund as their balance grows.”
Automatically defaulting employees into TDFs does not necessarily ensure that those employees will use them in a particular way, the study found. Even when employees started with their entire retirement portfolio invested in a TDF, just 57% stayed fully invested in that fund 5 years later. Rob Austin, Aon Hewitt’s director of retirement research, suggests that employers consider educating participants concerning diversification of their retirement fund investments in order to help them maximize returns.
The Financial Engines/Aon study will certainly fuel the debate over whether participants are sabotaging their own efforts to achieve optimal results from their accumulation strategy by failing to use their TDFs properly. In tomorrow's Daily, Jerry Bramlett will take a deeper dive into that issue.
