Many Target-Date Investors Also Invest in Other Funds

Retirement plan participants invested in target-date funds along with other funds offered by the plan could end up with a potentially inferior portfolio in terms of risk/return tradeoff, according to a study by the Employee Benefit Research Institute (EBRI).

The study in the December EBRI Notes pointed out that target-date funds were designed to be “all-in-one” portfolios that diversify asset allocations and rebalance over time based on a defined target-date horizon, benefitting participants who lack financial literacy or desire to manage their investments. “However, holding TDFs with other funds could lead to an unexpected result of ending up with a potentially inferior portfolio in terms of risk/return tradeoff from more assets allocated to some sectors than the designers of the target date funds had planned,” according to the study.

The study found that “mixed” target-date fund users, or target-date fund users who hold the funds in combination with other funds in their 401(k) plan menu, accounted for about 55% of all participants holding target-date funds in their accounts as of the end of year 2007. Mixed target-date fund investors are likely to be middle-income and middle-wealth participants, whereas participants who only invested in target-date funds are likely to be younger or lower-salaried participants who were automatically enrolled into the target-date funds.

In addition, mixed target-date fund users are more likely to hold multiple target-date funds than are users who invest only in target-date funds, and low-level mixed target-date fund users (who invest less than half of their account balances in the funds) are more likely to use two or more target-date funds than are high-level mixed users (who invest more than half their balance in the funds), according to the study.

EBRI also said mixed users holding relatively aggressive target-date funds for their age group (such as someone in their 50s investing in a 2050 fund) are more likely to actively invest in equity funds than those following age-specific investment rules.

The study used a sample from the 2008 EBRI/ICI 401(k) database looking at plans having at least 10 participants and offering any target-date funds in 2008. The sample includes participants ages 20 to 69 with account balances between $10,000 and $250,000 as of year-end 2008.