401(k) plans are all about automation these days, especially target date funds, which keep workers’ accounts in balance for an age-appropriate level of risk. It’s the investing world’s version of cruise control, but a study released today finds that many investors are turning on cruise control while putting their feet on the gas pedal – a move that’s hurting their returns.
The study looks at several forms of investing help that 401(k) plan sponsors provide to employees, and the news is encouraging. Workers who use target date funds (TDFs), professional account management or online advice get 3.32 percent better returns – even after the cost of those services – than those who go it alone. That may not sound like a lot, but it adds up: The researchers calculate that it could translate to a 79 percent account balance gain for someone age 45 today at age 65.
But the findings on TDFs should set off alarm bells for plan participants and sponsors alike. These funds are designed as one-stop investment solutions that automatically keep your account balanced between stocks and fixed-income investments to an age-appropriate level; as retirement gets closer, the amount of riskier equities is reduced. The idea is to put all, or nearly all, of your account balance into the TDF and let it ride.
Only 37.8 percent of participants investing in TDFs were using them as a “one-stop” investment, however, according to the study. Among those who split their investments with other mutual funds, only 35 percent was invested in the TDF, on average. Even more worrisome, 42 percent of investors who had 50 to 95 percent of their portfolios in TDFs had 90 percent of the remaining portion of their portfolios invested in the stock of their own companies – a potential over-concentration that can make the portfolio significantly more risky than necessary.
This partial target date usage had a negative impact on returns. Median annual returns for 2010 to 2012 were 2.44 percent lower than for participants who used help of all kinds, after fees. Learn more at Reuters Money.