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Maturity funds have exploded in popularity over the past 15 years, but many investors are not using them as intended.
The funds were designed as a one-stop shop that put retirement savings on autopilot. Investors are supposed to put their nest egg in a single fund, usually based on their year of retirement, which automatically switches from stocks to bonds over time.
However, a third of investors are not limited to a single target date fund, according to Vanguard 401 (k) data. They accumulate other funds on top of that.
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Specifically, 27% use TDFs with other 401 (k) mutual funds (like an S&P 500 index fund, for example). Another 2% uses more than one target date fund; 4% use two or more FDTs and other funds.
Those who use the funds in this way may inadvertently take on more investment risk, according to financial advisers.
“That’s not what you’re supposed to do,” said Ellen Lander, founder of Renaissance Benefit Advisors Group, based in Pearl River, New York. “Do I think it’s detrimental? Maybe and maybe not.”
Employers began to adopt target date funds with greater regularity after Congress passed the Pension Protection Act of 2006. The legislation provided legal protections for companies that automatically enrolled workers in the 401 (k ) of the company and invested their money in TDFs.
Today, 80% of 401 (k) plans offer a target date fund, according to the Plan Sponsor Council of America. The funds hold 24% of all assets in 401 (k) plans, most of all investment options, according to the trade group.
Of the plans that offered a TDF last year, six out of 10 dollars went into such a fund, according to Vanguard, which is the largest maturing fund manager.
Here’s how they work: Suppose an investor aims to retire in 2040, at age 65. This investor would choose the 2040 target date fund. The fund starts with a broad allocation to stocks and turns to cash and bonds over time.
“They’ve done a lot to move things in a more positive direction for many investors,” said Christine Benz, director of personal finance at Morningstar, of how TDFs have simplified the investment process.
But investing in additional funds can skew asset allocation. Investors who do not rebalance could end up with more risk than they would like.
For example, if an investor allocates half of 401 (k) assets to a target date fund and the rest to aggressive growth funds, the TDF would automatically adjust over time but holding 50% of the shares would remain. constant.
“This is where it’s probably detrimental,” Lander said. “I took a strategy designed for my age and my level of risk and made it extremely aggressive.”
In some 401 (k) plans, more than half of target date investors use them in conjunction with other funds, according to Lander, who consults with employers about their retirement plans.
“I think it’s probably not in the best interest,” said Aaron Pottichen, senior vice president at Austin-based Alliant Retirement Consulting, of using TDFs in this way.
The trend probably emerged for several reasons. On the one hand, investment diversification is commonly preached to retirement savers. Owning multiple funds may therefore seem like a logical extension. But in this case, TDFs are already diversified.
“It’s not clear to the employees that TDF is made up of five to 30 other funds,” Lander said. “If you look at your registration form, it is listed there as a fund.”
And investors shouldn’t necessarily bear all the blame, advisers say. Pension portals can be confusing for investors, for example.
Suppose a 401 (k) investor who has been automatically enrolled in a target date fund wants to take a do-it-yourself approach and hand-select their equity and bond funds. This person can change their future allowance but forget to change how their current dollars are invested if the web portal is unclear.
It looks like the trend is improving, however. Ten years ago, nearly half of TDF investors used more than one fund, up from 33% today, according to Vanguard.
“Directly this is a very good trend,” said Benz.
And there are defensible reasons for investors to have funds beyond a single TDF, the advisers said.
For example, a 62-year-old investor may hold parallel savings in a money market or stable-value fund, in addition to the target date fund, as a more liquid compartment of safe money for a possible down payment on a condo, Benz said.
Some may also want to tailor their asset allocation to a more specific degree than the target date funds of a 401 (k) plan are able to provide, the advisers said.
“There may be a reason for this,” Lander said. “I think it’s for a very small group of people who would even have the time, interest, or knowledge to do it.”
“Do I believe that is why this is happening? No,” she added.