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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

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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