Retirement, Financial Planning

TDFs Are Popular But Not Always Used As Intended

6/27/18 8:00 AM

/iStock-462756183.jpgThe primary goal of the Pension Protection Act of 2006 (PPA) was to shore up the finances of the federally guaranteed pension insurance fund. However, this legislation also brought with it several beneficial changes in how 401(k)s operate. For example, the PPA provided fiduciary cover for plans using certain “auto pilot” features, in turn making it easier for more employers to automatically enroll workers into 401(k)s at a default savings contribution rate, as well as to escalate that deferral rate automatically on a periodic basis. We have looked at several reports this month which showed how the adoption of such plan features has surged since the law’s enactment.

The Pension Protection Act also sanctioned the use of target-date funds (TDFs) as a qualified default investment alternative (QDIA). These hybrid mutual funds not only provide diversification but also systematically adjust the mix of stocks, bonds, and cash equivalents so that the holdings are more appropriate for a particular investor’s nearness to retirement, i.e. a target-date fund’s risk tolerance becomes more conservative over time. That automatic rebalancing feature has helped TDFs become quite popular in recent years, especially among 401(k) investors who do not want to have to worry about making the necessary age-related portfolio adjustments themselves.

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Further, a recent Vanguard study revealed that TDF use has more than doubled over the past decade, and the researchers expect that roughly three out of every four defined contribution plan participants will be invested in a target-date fund by 2022. However, even though a lot of money is flowing into TDFs, these investment products are not always being used exactly as intended. Indeed, TDFs are designed with the assumption that virtually all of a person’s retirement assets will be invested in such funds. An earlier report from Financial Engines, though, found that only 26 percent of surveyed TDF participants could be classified as “full-TDF users” with at least 90 percent of their plan assets invested in TDFs.

It is understandable that some people may be hesitant to keep all their (nest) eggs in one basket, and that is basically what 62 percent of partial-TDF users cited as the reason for decreasing their total TDF investment. Many partial-TDF users also said that they moved a portion of their assets away from TDFs because they wanted more personalized guidance on their retirement investments from a professional financial advisor. Other respondents said that they avoided TDFs because they simply did not fully understand the inner workings of these investment vehicles, yet another reason why participants could likely benefit from employer initiatives aimed at educating workers about available plan offerings.

  


 

Sources: Vanguard, Financial Engines

Post author: Charles Couch

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