While target-date funds are intended to be used as a singular option in capital accumulation plans, many defined contribution plan members use them in conjunction with other investments, according to research by Morningstar Inc.
The report noted more than 10 million DC participants are potentially in TDFs and other plan investments. “While combining target-date funds with other investments may not seem problematic at first glance, it can diminish (or eliminate) the target-date fund’s potential benefit,” the report said.
The profile of these mixed investment users suggests they’re more sophisticated than members who are just opt for the default investment option, but less sophisticated than members who take a self-directed approach and don’t use TDFs, the report said.
On average, mixed users hold a portfolio comprised of 37 per cent TDFs, 49 per cent equity funds and 13 per cent bond funds. The report suggested TDFs can appear to be a single investment to less sophisticated members who don’t realize they’re actually multi-asset strategies, prompting them to add other investments to the mix. Yet, in reality, TDFs are intended to be stand-alone.
The report recommended that DC plan members who want to be more aggressive should select a different vintage of TDF to increase the risk level of the underlying investments, rather than trying to up the risk level of their portfolios by adding other investments.
“For example, if a participant thought the equity allocation in the 2025 target-date fund vintage was too conservative, he or she could select the 2050 vintage to achieve this more-aggressive risk level,” it said. “While moving along the glide path results in a mismatch between the actual and expected target dates, it keeps the participant entirely in a professionally managed portfolio.”
For plan members who aren’t interested in using only TDFs, their plan sponsors should ensure they’re communicating the best options effectively, the report noted. “Plan sponsors should communicate to participants who are not interested in using the target-date fund in its entirety that they should consider some type of in-plan advice solution, such as advice or managed accounts.”
This article originally appeared on Benefits Canada‘s companion publication, the Canadian Investment Review.