Study Finds Lack of Understanding of Target-Date Fund Diversification

February 16, 2011 (PLANSPONSOR.com) – Focus group discussions conducted by the Center for Financial Security at Boston College provided insight into the reasons some retirement plan participants mix target-date funds with other investments in their retirement portfolios.

From the focus group discussions, the study concludes that trust, lack of financial knowledge, desire for control, information overload, and diversification heuristics may all be contributing to portfolio decisions.   

Pure target-date investors acknowledged their lack of financial knowledge and viewed target date funds as an easy and secure way to save for retirement. However, many mixed investors did not view target-date funds as a stand-alone solution, according to the study report.   

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When asked why it was not a stand-alone option, many in the focus groups appeared to be applying a simplified diversification heuristic: “Don’t invest all of your savings in a single fund”, demonstrating a fundamental misunderstanding of the inherent diversification offered by one target-date fund.  

Other mixed investors cited a lack of trust in putting money into a fund managed by a small set of people or maybe even just one person. They indicated that it would be more ideal to invest in multiple target-date funds managed by different people and with different underlying assets.  

In addition, the Center randomly surveyed approximately 2,000 participants divided into three groups – pure target-date investors, mixed investors, and non-target-date investors – and found similar results. Pure investors’ top reasons for investing their account in one target-date fund were because it was an easy way to diversify (88%) and because it was a simple investment option (87%). Seventy percent also liked that target-date funds did it for you because they were not familiar with investing. Almost half (49%) reported choosing the funds because they did not want to make their own investment choices.   

Meanwhile, 75% of self-reported mixed investors reported they chose a mixed strategy because they felt they needed other investments in addition to target-date to be adequately diversified. In addition, many mixed-investors (70%) reported wanting to “dial up” the risk in target-date funds by holding other more aggressive funds. Other important reasons for mixed investor behavior included wanting to customize the portfolio beyond target-date funds (69%) and wanting to limit target-date funds to only part of their portfolio (67%). Non-target date fund investors also reported wanting to make their own investment choices (60%) and not wanting to have all their money in one fund (57%).

Information Overload  

The random survey of approximately 2,000 retirement plan participants by the Center for Financial Security at Boston College finds investment information overload can result in less decisionmaking. The survey found individuals that report spending less than a moderate amount of time setting their initial allocation also tend to fall more often into the high information overload category (56%) relative to those who spend more time (43%).  

Similarly, those who do not systematically review their portfolio have a greater percentage of individuals in the high overload category (64%) compared to those who review more often (45%).   

Similarly, the Center examined individuals who were unsure of their investments or unaware of target-date funds and 61% of those participants were also in a high information overload category—versus 45% of participants who knew their allocations. Seventy-one percent of those looking for someone else to make decisions were in the high overload category, versus 45% of other respondents.   

From these results, it appears that individuals who experience high overload are more likely to be individuals who spend less time on their portfolios, are less sure of their allocations and wish for someone else to make their decisions, the study report concluded.  

The Center’s report is here.

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