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Target-Date Funds May Not Play Well With Others in Defined-Contribution Plans

Morningstar research explores the profiles of investors who mix target-date funds with other investment options

David Blanchett, Morningstar Investment Management LLC

 

Target-date funds are designed to simplify investing for participants in defined-contribution plans, especially in plans that use them as the default investment. However, participants sometimes combine target-date funds with other investment-plan options, thus becoming what’s known as mixed target-date fund investors.  

While combining target-date funds with other investments may not seem problematic at first glance, it can diminish—or even eliminate—the target-date fund’s potential benefit.

This issue is especially noteworthy given the potential number of affected investors, which could easily exceed 10 million defined-contribution-plan participants today (based on a conservative estimate that 10% of defined-contribution-plan participants engage in mixed target-date fund investing). 

In my latest research, “Mixed Target-Date Fund Investors: Is There a Method to the Madness?” I explored the allocation decisions of 30,516 mixed target-date fund investors to determine which types of investors are more susceptible to mixing target-date funds and how they mix them.

The hope is to use these results to reduce the incidence of mixed target-date fund investing. 

3 findings about mixed target-date fund investors 

  • They aim to make their portfolio more aggressive through core funds. Their allocation decisions tend to make their portfolio more aggressive than a target-date fund with an appropriate vintage (or target-date portfolio year). In fact, their allocations are consistent with a retirement year that is 10 years later than their actual vintage.

  • They tend to hold less than half of their portfolio in the target-date fund. Overwhelmingly, they combine the target-date fund with equity funds. For example, my research showed that the average allocation of mixed target-date fund investors is 37% target-date funds, 49% equity funds, and 13% bond funds. The non-target-date fund weights are relatively constant across various levels of target-date fund holdings. 

  • They are relatively similar to other investors who decide to self-direct their accounts. Compared with default investors, self-directing investors tend to be older, with higher salaries, balances, and deferral rates; they might be classified as more sophisticated. However, mixed target-date fund investors appear to be slightly less sophisticated than the rest of the self-directing population (they tend to be younger, with lower plan tenures, deferral rates, salaries, and balances). So, mixed target-date fund investors’ average level of sophistication appears to fall between that of default investors and that of self-directing investors. 

Investment strategies target-date fund investors may consider 

Rather than mixing a target-date fund with equity or bond funds from the core menu, an investor seeking a more aggressive allocation would do well to move along the target-date-fund glide path but select a vintage with a higher risk level.  

For example, if a participant thought the equity allocation in the 2025 target-date-fund vintage was too conservative, he or she could achieve a more-aggressive risk level by selecting the 2050 vintage. Though moving along the glide path results in a mismatch between the actual and expected target retirement dates, it can help by keeping the participant entirely in a professionally managed portfolio.  

And when it comes to overseeing participants who are not allocating to the target-date fund in its entirety, plan sponsors may consider nudging them toward a type of in-plan advice solution, such as advice or managed accounts

To read the research, download “Mixed Target-Date Fund Investors: Is There a Method to the Madness?”

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Morningstar Investment Management LLC is a registered investment adviser and subsidiary of Morningstar, Inc. The Morningstar name and logo are registered marks of Morningstar, Inc. Opinions expressed are as of the date indicated; such opinions are subject to change without notice. Morningstar Investment Management and its affiliates shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use. This commentary is for informational purposes only. The information data, analyses, and opinions presented herein do not constitute investment advice, are provided solely for informational purposes and therefore are not an offer to buy or sell a security. Before making any investment decision, please consider consulting a financial or tax professional regarding your unique situation.  

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