Should you create a separate 401(k) contribution default setting for plan participants based on demographic factors? A qualified “yes” is the conclusion of a study released this month by Financial Engines, an independent money manager with over $100 billion in retirement assets under management.

The study’s primary topic is summarized by its title: “Why target-date funds are widely misused by retirement investors.” It was based on an online questionnaire completed by 1,013 defined contribution plan participants between the ages of 18 and 70, with 91% clustered between 25 and 64.

Nearly three-fourths (73%) of survey respondents have incomes between $25,000 and $100,000, and nearly two-thirds (66%) have less than $300,000 in plan assets.

One of the study’s basic conclusions is that a high proportion of target date fund investors “misuse” them because they fail to appreciate that if they don’t invest all of their retirement assets in a TDF, then they need to balance, and routinely re-balance, their other retirement assets in sync with the TDF’s evolving asset allocation in mind in order to achieve the results the TDF is designed to achieve.

For example, if a retirement plan participant accepts (consciously or unconsciously) the wisdom of a TDF’s 70/30 stock/bond asset allocation at a particular age, and has only half of his 401(k) assets in the TDF and all the remaining funds fully invested in stocks, his combined asset allocation would be 88/15. Or if all the remaining funds instead were in bonds, the ratio would be 35/65 instead of 70/30.

Investment performance impact

The study revealed that only one-fourth of surveyed plan participants have their entire 401(k) funds invested in a TDF. An earlier study by Financial Engines and Aon Hewitt concluded that the “partial approach” (i.e., having less than all of one’s 401(k) assets in a TDF) “resulted in 2.1% lower median annual returns, net of fees, than investors who held most of all their retirement assets in TDFs,” the current study recounts.

“The high incidence of partial TDF usage, and the evidence that such partial TDF-users significantly underperform more appropriately diversified investors, calls into question the efficacy of relying solely on TDFs to achieve retirement security for plan participants,” the study asserts.

According to Financial Engines, several of the firm’s large plan sponsor clients have already taken this lesson to heart. They have been “refining their automatic enrollment practices by also beginning to default older existing employees into managed accounts and other advisory services, which better meet their more complex needs not addressed by TDFs.”

Financial Engines isn’t the first to call for this approach. In its 2015 Retirement Markets report, financial services industry researcher Cerulli noted the following: “While highly unusual at this point in time, it is possible for plan sponsors to design the DC plan to reflect a view that managed accounts are a better solution for the plan’s older and/or more affluent participants.”

Demographic patterns

The Financial Engines study’s detailed analysis of TDF utilization patterns by participant demographic supports the recommendation of an age-based approach to varying the default investment. For example, overall, only 25% of surveyed participants invest 90% or more of their retirement savings in a TDF.

These “full TDF users,” as the study calls them, “differ markedly from the average plan participant.” They generally are younger, earn less and have smaller plan account balances, than the 67% of “partial TDF users.” The lower earnings and smaller account balances typically go hand-in-hand with the younger participant age, of course.

It is probable that the higher proportion of “full TDF users” among younger participants stems from their having been defaulted into TDFs from the beginning of their employment, a circumstance that would not have occurred for older participants who began participating before QDIAs and TDFs gained prominence.

Also, only 15% within this younger group reported thinking “a great deal” about plan investments, and 60% report preferring a “set it and forget it approach” to retirement investing.

In contrast, partial TDF users were older and more affluent participants.


The study also segmented participants who had moved some or all of their 401(k) funds out of TDFs. Those participants “tend to be particularly overconfident,” according to the study. That conclusion was drawn from the finding that “62% of them believe they can achieve better returns through their own investing… despite evidence to the contrary.”

But many of these “decreasers” also expressed a desire for “more personal management or advice,” the foundation of the managed account.

Those two factors and other data elements lead Financial Engines to the conclusion that “TDFs appear to be most effective for younger investors with low asset balances and others with less complex financial needs.”

But for participants with more complex needs, managed accounts “can play a crucial complementary role to TDFs [as a QDIA] in a well-designed workplace retirement plan,” the study concludes.

Financial Engines’ conclusion echoes that of Cerulli in its 2015 Retirement Markets report. “This combination of a target-date and managed account solution is certainly further out on the curve compared to the industry’s current thinking, but for managed account to be incorporated in an impactful and cost-efficient way, it will require a creative approach.”

But it will also require “careful review by a plan’s ERISA counsel,” Cerulli cautioned.

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