Defusing the Target-Date Time Bomb

The trend of auto-enrolling employees into defined contribution plans is accelerating.

By editors@assetinternational.com | December 05, 2013
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Consider this volatile mix:

1.     Auto-enrollment is proliferating,

2.     Target-date funds are used heavily in auto-enrollment,

3.     Target-date funds are equity-rich,

4.     Many younger workers are auto-enrolled into target-date funds,

5.     Gen Y is highly risk-adverse, and

6.     The next severe market downturn could see droves of participants selling at the bottom and not getting back in.

 

Industry data varies, but it seems safe to say that more than half of plans now do some form of auto-enrollment.  By far, the most common use of auto-enrollment is with new hires.  Not all new hires are younger workers, but it is probably safe to assume that many of them belong to Gen Y. 

About two-thirds of auto-enrollment programs utilize target-date Funds (TDFs) as the default investments.  Default investments tend to be “sticky.”  People who lacked the inertia to opt-out or to select their own enrollment options to begin with are unlikely to take the initiative to learn about and undertake the process of changing their investment elections—at least, not while the market is doing well.

The TDFs into which these individuals are being enrolled are equity-rich.  Members of Gen Y would likely have equity allocations of 80% to 90% in the long-dated TDFs.  However, much has been written about the risk-adverse nature of Gen Y.  Through their formative years, the U.S. experienced a severe recession and the worst bear market since the Great Depression.  Many are struggling with high education debt, and are grappling with a very challenging job market.  They have neither the disposition nor the financial wherewithal to incur large losses.