Target Date Funds Misunderstood
A new survey by ING revealed gaps in investor understanding of how target date funds are designed, how they are managed, and what they are designed to do. The survey interviewed 540 defined-contribution plan participants. Within this group, 212 invested in target date funds and 328 did not.
A target date fund provides exposure to a variety of assets, most notably large-cap stocks and bonds, and adjusts its allocation as it approaches a specified date (e.g., 2020). These funds are designed to give investors a simple option for reaching their long-term goals. Their management styles and allocation strategies can very widely, however, with some funds designed to make an abrupt shift in allocations at the target date (the “to” approach) and others designed to make a gradual change (the “through” approach). Hence, the opportunity for misunderstanding and confusion about these funds is high.
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An example of the confusion concerns controlling risk. More than 70% of all respondents (79% of target date fund users and 71% of non-users) said they wanted stronger protection from investment losses. Yet only about half (55%) knew a target date fund’s allocation was designed to become more conservative over time. Worse yet, just 44% thought the allocation would be automatically changed over time. And just 53% were confident they would reach their retirement goals. (Among respondents who did not use target date funds, the percentages were even lower.)
The confusion extends to portfolio allocation. Both target date fund users and non-users thought diversification is important, with more than 80% of all respondents indicating an interest or strong interest in diversification. However, less than-two thirds (63%) of target date fund users believed their funds held a diversified mix of stocks and bonds. This may partially explain why 47% of target date fund users thought they needed to own other funds to obtain more diversification.
A target date fund can play a role in a portfolio if an investor understands the fund’s investing and allocation strategy. Specifically, investors need to read the prospectus to learn how the allocation changes over time and what happens after the target date is reached. It is also very important to find out if the allocation will continue to evolve after the target date and at what point the fund will be liquidated or folded into another fund.
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