Target-date funds (TDFs) are designed to simplify investing for participants in defined contribution (DC) plans, especially in plans that use them as the default investment. However, there are potentially more than 10 million participants in DC plans today combining a TDF with other plan investments, commonly referred to as “mixed target-date fund investors,” according to a report from Morningstar.

“Combining target-date funds with other investments may not seem problematic at first glance, [but] it can diminish (or eliminate) the target-date fund’s potential benefit,” David Blanchett, head of Retirement Research at Morningstar Investment Management LLC, says in the report, “Mixed Target-Date Fund Investors: Is There a Method to the Madness?”

Blanchett explored the allocation decisions of 30,516 mixed target-date fund investors to determine which types of investors are more susceptible to mixing target-date funds and how they mix them, with the hope of using the results to reduce the incidence of mixed target-date fund investing.

While the incidence of mixed target-date fund investing has improved over the years, still, many participants who are older, with higher salaries, balances and deferral rates choose to put a portion of their balances in other investments. Similar to other investors who decide to self-direct their accounts (compared with default investors), they would generally be classified as more sophisticated. However, Blanchett says when comparing mixed target-date fund investors to other self-directors, mixed target-date investors appear to be slightly less sophisticated.

A Vanguard study earlier this year found nearly one-third mix TDFs with other investments and “are pursuing what appear to be reasonable diversification strategies.” Blanchett agrees, but says their allocation decisions tend to make them more aggressive than a TDF with an appropriate vintage (that is, target retirement year). Their allocations are consistent with a retirement year that is 10 years later than the actual vintage they should be in. He found mixed TDF investors tend to have less than half of their portfolio in the TDF and overwhelmingly combine the TDF with equity funds. For example, the average allocation of mixed TDF investors is 37% TDFs, 49% equity funds, and 13% bond funds.

Blanchett cites a 2017 study that estimated the majority (55%) of participants who mix TDFs with other investments do so out of choice, while the remainder (45%) stem from plan sponsor decisions, such as including employer contributions in company stock, nonelective contributions to the plan’s default fund, and so on. A 2011 study from Vanguard found the same.

Additionally, the 2017 study cited found half of the mixed TDF investors become mixed at enrollment, while one-third were not invested in a TDF but added it to their portfolio at some point.

Blanchett also cites a 2016 Financial Engines study which found participants who were mixed TDF investors thought doing so could lead to outperformance; were concerned about “putting all their eggs in one basket,” despite the TDFs are already incredibly diversified (and 82% reported knowing as such); and were seeking greater personalization than the TDF alone could provide.

Blanchett suggests an investor who would like a more-aggressive allocation would generally be better off moving along the TDF glide path by selecting a vintage with a higher risk level than mixing the TDF with equity (or bond) funds from the core menu. For example, if a participant thought the equity allocation in the 2025 TDF vintage was too conservative, he could select the 2050 vintage to achieve this more-aggressive risk level. “While moving along the glide path results in a mismatch between the actual and expected target dates, it keeps the participant entirely in a professionally managed portfolio,” Blanchett says.