How Participants are Using Target-Date Funds

Abstract

Despite their growing popularity, there is relatively little research that delves into how retirement plan participants are using target-date funds. The funds were designed to offer one-step investing for retirement: All investors need to do is select a retirement date and their retirement assets will be professionally managed, becoming more conservative as the target-date nears and continuing to gradually allocate more of the portfolio to fixed-income investments throughout retirement. However, early anecdotal evidence suggested that participants were investing in target-date funds as well as other funds - sometimes even multiple retirement date funds. This study of participant behavior in a sample of retirement plans recordkept by T. Rowe Price examines who is investing in target-date funds and how these participants are using the funds - comparing behavior in automatic enrollment plans to that in opt-in plans (plans that require employees to take action to enroll). The findings are as follows: • Participant usage of the funds is high in both automatic enrollment and opt-in plans. Over half of all participants (in plans that offer them) hold target-date funds. Automatically enrolled participants are much more likely to invest in them, and they tend to migrate to other investment options over time. • There is a negative relationship between the number of other funds offered and the likelihood of target-date fund use. • The longer target-date funds have been offered by a plan, the more likely participants (even new participants) are to invest in them. • Relative to other participants, target-date fund investors tend to be younger, shorter-tenured, and lower-income employees. They also have a lower household income. • A very high percentage of participants in plans recordkept by T. Rowe Price are investing in target-date funds exactly as they were designed to be used: Over 80% of target-date fund investors are allocating 100% of their contributions exclusively to one target-date fund. • In every age group, target-date fund investors have higher average equity allocations than their counterparts, with the gap approaching 20 percentage points for the 26 to 35 age group (87% versus 68%). The gap narrows to nine percentage points (64% versus 56%) for the 56 to 65 age group. • Finally, the use of target-date funds eliminates (when they are the sole investment) or reduces (when they are used along with other investments) extreme allocations to equities. The study finds that in every age group, a high percentage of participants who do not invest in target-date funds have either none or more than 90% of their retirement assets allocated to equities. The primary implications of this research include the following: Early arguments against target-date funds due to widespread participant misuse are no longer well founded, based on this analysis of the behaviors of the participants of T. Rowe Price’s clients. However, there is still room for improvement. Automatically enrolled participants whose contributions are defaulted into target-date funds are much more likely to use them than participants in opt-in plans. To the extent that plan sponsors believe target-date funds establish a more appropriate risk-adjusted approach toward helping participants achieve their retirement goals, they may wish to consider automatically defaulting participant contributions into age-appropriate target-date funds. However, over time many of these automatically enrolled participants migrate to other investments. Therefore, plan sponsors will want to continue to monitor participants’ decision making. This may identify future education and communication needs to help overcome any observed suboptimal behaviors.