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Educating Employees about Age-Based Retirement-Savings Options

February 20, 2018

Target date funds ( TDFs) are designed to be the only investment vehicles that an investor uses to save for retirement. When someone mixes their investments, he or she stands the risk of an unbalanced portfolio.

Does your 401(k) plan have a large percentage of “mixed target date fund (TDF)” investors? If so, it may be time to teach them how to review their investment options and encourage a more balanced mix. Here’s more on this common problem.

What Are Mixed TDF Investors?

TDFs are designed to meet the investment needs of typical 401(k) plan participants at any age. They automatically adjust over time from a higher concentration of stocks to a smaller one as employees approach and proceed through retirement. TDFs are intended to relieve excessive worrying about how participants’ assets are allocated between stocks, bonds and cash.

Research indicates many plan participants don’t fully understand the TDF concept, causing some employees to misallocate their retirement savings. While TDF-only investing can be an unwise strategy over the long run, the Employee Benefit Research Institute (EBRI) has identified another TDF peril: the so-called “mixed TDF investor.” That’s someone who considers TDFs to be equivalent to an ordinary mutual fund and continues to invest a substantial proportion of the portfolio elsewhere to avoid “putting all their eggs in one basket.”

The downside, warns EBRI, is that such investors could “end up with a potentially inferior portfolio” — or at least one that’s unbalanced.

What Could Go Wrong?

To understand how mixed TDF investors can misallocate their savings, consider a 45-year-old 401(k) participant whose optimal retirement portfolio allocation is, say, 70% stocks and 30% bonds. Suppose that participant decides to “diversify” her retirement portfolio by putting 1) half in a TDF with 70% stocks and 30% bonds, and 2) the other half in aggressive equity mutual funds.

How would this hypothetical setup affect the participant’s aggregate asset allocation? In this case, the participant’s portfolio would consist of 85% stock and 15% bonds. Conversely, if the second half of the portfolio were invested in a bond fund, the aggregate asset allocation would be 35% stocks and 65% bonds.

Those examples are extreme to demonstrate the principle. Chances are, your employees won’t be quite so far off track. Even so, misallocations could still lead to some unpleasant surprises over time.

How Can Plan Sponsors Help Avoid Misallocations?

The problem typically relates to inertia. For example, participants might start putting new deferrals into a TDF when it becomes available, but then they leave the existing balance invested some other way without looking at the aggregate allocation. In other cases, participants diversify by asset manager, without paying enough attention to the fund’s overall composition.

Plan sponsors can help avoid the “inertia trap” by reviewing the extent to which misallocations are happening among plan participants. If the practice is widespread at your company, consider launching a simple educational program to ensure that participants are clear on the purpose of TDFs and their role in a retirement savings portfolio.

Need Help?

Contact us if you need help rolling out your TDF education program. Our employee benefits specialists know how to explain the pros and cons of these retirement savings tools in plain English and can help your employees achieve a more balanced portfolio based on their ages and risk preferences.

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