Investors are misusing their target-date funds, and it is not because they don't understand how they work. Overconfidence and a desire for greater diversification are why people can't seem to simply "set it and forget it," said Christopher Jones, chief financial officer at Financial Engines.
"People don't actually put all their money into a target date fund and remain there for the duration of their retirement," said Jones. "People have been abandoning them at a pretty good clip. By the time they get to a $75,000 or $100,000 balance, it was relatively rare for them to maintain a full investment in a target-date fund."
According to the Financial Engines report titled "Not So Simple: Why Target-Date Funds Are Widely Misused by Retirement Investors," almost two-thirds of target-date fund investors hold only a portion of their investments in the funds. In other words, by investing outside of their target-date fund, participants were seeking something beyond what their target-date fund could offer, thereby potentially harming their investment returns.
"The evidence shows that people who partially invest in target-date funds do a lot worse, about 2% less per year in terms of returns than folks that are fully invested in target date funds," said Jones.
Interestingly, the study found that only 23% of those fully invested in target-date funds were "very confident" that their assets were appropriately invested, compared to 29% of those holding only part of their investments in target-date funds and 34% of those not invested in target-date funds at all.
"Target-date funds are designed to be a diversified investment," said Jones. "The problem is that they are a single fund and people have this uncomfortable notion that putting all of your money into one fund is somehow a bad thing to do."