Vanguard Study Sheds Light On TDFs

BOSTON ( TheStreet) -- New research by Vanguard may help ease concerns that many who intentionally choose target date funds in their retirement plans may not fully understand how they can, or should, work.

There remains, however, a knowledge gap among those who were defaulted into a TDF for their direct contribution plan.

The Vanguard study includes a survey of 4,700 investors in January. Overall awareness of TDFs was substantially higher among IRA owners than among plan participants, regardless of whether the respondent actually owned a fund, according to Vanguard. Roughly 95% of TDF investors in IRA accounts reported having "heard of a target date fund," versus 62% of TDF owners in defined contribution retirement plans.

"This is not surprising because IRA owners must affirmatively choose to invest in a TDF," the study says.

Conversely, 401(k) plan participants who own a target date fund but reported that they had never heard of them may have responded that way because of automatic plan enrollment, through which plan sponsors can place them in qualified default investment alternatives, including TDFs.

"Defaulted participants are generally unlikely to take any active role in investment decision-making and so may be much more likely to be unaware of not just TDFs, but also of other features of their retirement plan," Vanguard's study says, estimating that half of the participants holding TDFs in 2009 were defaulted into them.

"It is encouraging that many plan participants are aware of target date funds," John Ameriks, head of Vanguard Investment Counseling & Research, says in a statement. "Participants who are not aware of TDFs are likely to be unengaged investors -- and these funds are intended to provide such investors with a prudently diversified portfolio. The existence of a sizable 'unaware' group of investors is perhaps the major reason why target date funds were created in the first place."

The research emphasizes that being unaware -- or uninformed -- about TDFs is considerably different than being misinformed or misled. A vast majority of the "aware" participant TDF holders understood the fundamental goal and design of the funds, acknowledged that they involve risk and reported accurately that they offer no guarantees.

Other findings included:
  • 77% knew that the asset allocation becomes more conservative as the target year approaches, showing an understanding of these funds' changing asset allocation.
  • 87% believed target date funds involve "some risk" or more; less than 1% felt they were risk free.
  • Only 8% of participants incorrectly believed that target date funds provide "guaranteed income." Just 4% of participants incorrectly indicated TDFs provide either a guaranteed return or become risk free at the target date.

While target date funds are "designed to provide broad diversification in a single portfolio," many investors hold other investments along with a TDF, Vanguard found. Of the participants holding such a "mixed" portfolio, 56% say they did so to hold more aggressive investments. Another 41% thought they needed a mixed portfolio for adequate diversification.

"These investors may have embraced participant education messages about the risks of holding only one fund and 'putting all your eggs in one basket' more literally than necessary," Ameriks says.

-- Written by Joe Mont in Boston.

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