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Some investors in target-date funds, a rapidly growing default option in 401(k) retirement plans, apparently do not understand the purpose of the funds and could end up with a potentially inferior portfolio in terms of risk/return trade-off, according to a study by the not-for-profit Employee Benefit Research Institute (EBRI) in collaboration with the Investment Company Institute (ICI), a trade association representing U.S. mutual fund and other investment companies.
The study, published in the December 2009 issue of EBRI Notes, reports that at year-end 2008, nearly 7 percent of 401(k) assets were invested in target-date funds (TDFs), according to the EBRI/ICI 401(k) database. Among participants in their 20s, 15 percent of their 401(k) assets were invested in target-date funds, while among participants in their 60s, almost 6 percent of their 401(k) assets were invested in the funds.
------------------------------------------------------------------------Nearly 7 percent of 401(k) assets were investedin target-date funds at year-end 2008.------------------------------------------------------------------------
This growth is the result of recent legislative and regulatory inducements—notably the U.S. Labor Department’s approval of target-date funds as a qualified default investment alternative in 401(k)-style defined contribution retirement savings plans, according to the study.
‘All in One,’ Not ‘Mix and Match’
Because 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, participants who lack financial literacy or desire to use institutional expertise in asset allocation and portfolio rebalancing might benefit from investing in these funds, the study notes.
“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 trade-off from more assets allocated to some sectors than the designers of the target-date funds had planned,” the study adds.
‘Pure’ vs. ‘Mixed’ Fund Users
The study finds that as target-date funds are offered to plan participants (on a default or voluntary basis), a new class of investors is emerging: TDF users who hold the funds in combination with other funds in their 401(k) plan menu. Target-date fund users holding other funds, referred to as “mixed” TDF investors, are likely to be middle-income and middle-wealth participants. Mixed target-date fund users accounted for about 55 percent of the participants holding TDFs in their accounts as of the end of 2007.
Those investing only in target-date funds are referred to as “pure” TDF investors. They are more likely to be young and low-salary participants who are enrolled into target-date funds automatically.
Overall, the study says, some mixed target-date fund investors “apparently fail to understand” that a TDF is designed as an “all-in-one” portfolio solution. For instance, mixed target-date fund users are more likely to hold multiple TDFs than are pure users who invest only in TDFs, 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 TDFs than are high-level mixed users (who invest more than half their balance in the funds).
In addition, mixed users holding relatively aggressive target-date funds for their age group (such as someone in their 50s investing in 2050 funds) are more likely to actively invest in a range of other equity funds than those who invest in an age-appropriate TDF.
The study uses 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 20-69 with account balances of $10,000 to $250,000 as of year-end 2008.
Stephen Miller is an online editor/manager for SHRM.
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