A majority of defined contribution participants are misusing target-date funds and causing their portfolios to take on too much or too little risk, according to a report issued Tuesday by Aon Hewitt and Financial Engines.
The main problem is target-date fund investors fail to use these funds as their sole investment, the report said. Instead, 62% of target-date investors also invest in other options.
“People are not using target-date funds as these funds are designed,” said Rob Austin, director of retirement research at Aon Hewitt, in an interview. “They are not going all-in.”
The Aon Hewitt-Financial Engines report identified “partial” target-date fund usage as DC participants investing less than 95% of their account balances in target-date funds. Among this group, target-date funds represented an average of 35% of a participant's portfolio.
As a result, some participants make other investments that cause their retirement plan portfolios to become too risky while others make investments that are too conservative, Mr. Austin said. The report said older participants take on too much risk and younger participants take on too little risk.
Those participants nearing retirement “were making more risk mistakes” than younger participants, the report said. “Near-retiree partial target-date fund users were especially vulnerable to market downturns.”
The report also showed that these investors periodically rebalanced their target-date fund portfolios, thus incorrectly applying the strategy of portfolio diversification.
“People hear that they should be diversified,” Mr. Austin said. “This is a knee-jerk reaction. It's a lack of understanding that a target-date fund is already diversified.”
As a result, the report said investment returns among the partial users of target-date funds trailed returns of target-date funds over all age groups over several years, the report said.
The research on target-date funds usage is part of the broader report, “Help in Defined Contribution Plans: 2006 through 2012” from Aon Hewitt and Financial Engines.
The report covered 14 DC plans with 723,000 participants and aggregate assets of more than $55 billion. The plans are clients of both Aon Hewitt and Financial Engines. Overall results are based on data from 2006 through 2012, although most data involving target-date funds is from 2012 and 2013.