Study hints at the problem with target date funds

Investors prefer to hedge their bets, and spread their assets among many strategies

By Ben Steverman

May 13, 2014 @ 7:12 pm EST

If you're in a retirement plan, chances are good that some of your assets are in a target date fund. Chances are even better that you're hurting your returns.

The growth of target date funds has been explosive. Two in every five 401(k) participants held target date funds in 2012, double their share in 2006, according to the latest Investment Company Institute data. More than half of 20-somethings with 401(k)s own them.

Retirement plans like target date funds because they offer participants an all-in-one solution. Workers choose the fund that matches their expected retirement year, and the fund re-balances automatically over time, adjusting the risk level. Younger workers get more stocks, which are riskier but tend to offer higher returns, and older workers more bonds.

Sounds great. But it won't work unless all of your money in the plan is in the fund. Mix and match with other plan funds and odds are you'll end up with just the wrong amount of risk. And that's exactly what's happening, according to a new study by plan investment adviser Financial Engines and consulting firm Aon Hewitt.

Surveying 14 large retirement plans with $55 billion in assets, the study found that just 38 percent of target date fund users rely on such funds for 95 percent or more of their portfolio. The other 62 percent mix them with other funds, allocating about a third to target date funds, on average. That partial exposure hurt investment performance by about 2 percentage points a year. The study found that almost a third of users wound up with too much portfolio risk, and about 30 percent with too little.

Target date funds are like a prix fixe menu, offering a well-balanced meal. But workers are treating them like a side order. They're scooping up some target date funds along with servings of bond funds, money market funds and international offerings. Like all bingeing, it's bound to make an investor feel sick.

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