There are conflicting opinions about defined contribution (DC) plan participants mixing target date funds (TDFs) with other investment options in their retirement portfolios? For a small percentage of participants, this might be a reasonable strategy, but for most it is not.
A recent article in the Vanguard Blog for Institutional Investors written by Cynthia Pagliaro endorses mixing TDFs with other investment options in a retirement savings account for participants who know what they’re doing, but this is a rare few.
The story by Vanguard found that approximately 22% of all TDF investors are “strategic mixed investors.” This small but savvy group may pair a TDF with another investment option that’s either more aggressive or conservative than the asset allocation inside their TDF, depending on their personal preferences and needs. As long as expense ratios remain reasonable, and participants are willing to accept the added responsibility of monitoring and managing these investments on their own, this practice of mixing investments could work well for them.
Of course, it isn’t for everyone. In fact, most of the industry frowns on mixing TDFs with other investments, claiming it’s a misuse of what is designed to be an “all-in-one” investment solution. But if we’ve learned anything since the passage of the 2006 Pension Protection Act, which ultimately fostered widespread adoption of TDFs as default investment solutions for many plans, it’s that participants are anything but typical.
So a “one-size-fits-all” TDF may not be the perfect fit for every participant. As such, it’s necessary that we adapt our thinking and support participants who want to explore more flexible, innovative investment allocations. That is, as long as they are making smart investment decisions that are in their best interests.
Additionally, mixed investing isn’t always participant-directed. Sometimes, there are plan-level reasons that participants are invested in a combination of TDFs and other investment options. Breaking it down by the numbers, in DC plans record kept at Vanguard that offered TDFs at year-end 2015, 70% of participants owned TDFs. Of these, 60% were pure TDF investors — owning no other investment option — and 40% were mixed investors who owned a TDF and other outside funds. Of the 40% mixed investors, nearly half were a result of plan sponsor actions, and more than half were participant-directed.
Mixed investments can happen at the plan level, for example, when a sponsor adds a TDF or other funds to a participant’s portfolio via employer contributions, makes recordkeeping changes, or swaps funds in the investment menu. So a participant who’s invested in a TDF but receives a match in company stock would be a mixed investor.
The good news is, sponsors are well within their fiduciary rights in situations like these, where participants become mixed investors through no action of their own. Participants can easily adjust a default allocation or exchange an employer contribution. However, sponsors should educate participants and make sure they understand the choices that are available.
Still, participants can get into trouble by choosing too many investment options, thus over-diversifying their portfolios. Vanguard found that approximately 4% of participants hold as many as eight funds, including a TDF. As such, they might have redundant funds in their portfolios, or end up paying excessive active management fees.
To help mitigate over-diversification risk, plan sponsors can offer managed account advisory services, which enable participants to customize professionally managed investment portfolios according to their specific needs. Sponsors might also consider implementing automatic enrollment or doing a re-enrollment to encourage participants to select just one target date fund.
While too much diversification isn’t advised, for more financially savvy participants who understand how to maximize the benefits of TDF combined with other funds, a mixed investment strategy might be just right.
Mr. Kelly is an expert in online marketing, search engine optimization, content development and content distribution. He has consulted some of the top brokerages, media companies and financial exchanges on online marketing and content management including: The New York Board of Trade, Chicago Board Options Exchange, International Business Times, Briefing.com, Bloomberg and Bridge Information Systems and 401kTV.
He continues to be a regular market analyst and writer for ForexTV.com. He holds a Series 3 and Series 34 CFTC registration and formerly was a Commodities Trading Advisor (CTA). Tim is also an expert and specialist in Ichimoku technical analysis. He was also a licensed Property & Casualty; Life, Accident & Health Insurance Producer in New York State.
In addition to writing about the financial markets, Mr. Kelly writes extensively about online marketing and content marketing.
Mr. Kelly attended Boston College where he studied English Literature and Economics, and also attended the University of Siena, Italy where he studied studio art.
Mr. Kelly has been a decades-long community volunteer in his hometown of Long Island where he established the community assistance foundation, Kelly's Heroes. He has also been a coach of Youth Lacrosse for over 10 years. Prior to volunteering in youth sports, Mr. Kelly was involved in the Inner City Scholarship program administered by the Archdiocese of New York.
Before creating ForexTV, Mr, Kelly was Sr. VP Global Marketing for Bridge Information Systems, the world’s second largest financial market data vendor. Prior to Bridge, Mr. Kelly was a team leader of Media at Bloomberg Financial Markets, where he created Bloomberg Personal Magazine with an initial circulation of over 7 million copies monthly.