Most Investors Understand Design and Risk of Target-Date Funds
VALLEY FORGE, PA, January 12, 2011 -- While there has been a great deal of speculation about investors' understanding of target-date funds, a new Vanguard survey finds that most target-date fund investors understand the funds' basic design and are aware of the accompanying investment risks.
In Investor Comprehension and Usage of Target-Date Funds: 2010 Survey, Vanguard also found that opportunities exist to improve investors' knowledge of target-date fund (TDF) mechanics at and around the target date, and the implications of combining TDFs with other assets.
Vanguard conducted the survey in January 2010 among more than 4,700 respondents, including Vanguard IRA owners and participants in Vanguard-administered defined contribution retirement plans who held target-date funds and a control group of Vanguard IRA investors and plan participants who did not own the funds. In addition to looking broadly at investors' awareness and comprehension of TDFs, the survey examined the decision-making process and retirement income expectations of TDF holders.
General Awareness of Target-Date Funds; Unaware Group May Not be of Undue Concern
Overall awareness of TDFs was substantially higher among IRA owners than among plan participants, regardless of whether the respondent actually owned a fund. Some 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. Meanwhile, 401k plan participants who own a target-date fund but reported that they had never heard of them may have responded that way as a natural result of automatic plan enrollment, through which plan sponsors can place participants 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. In a separate report, Vanguard estimated 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," said John Ameriks, head of Vanguard Investment Counseling & Research. "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. "The unaware are a critical group. They stand to benefit the most from fiduciary decisions that plan sponsors must make when selecting and monitoring default funds. The use of well-diversified funds such as target-date funds can be very effective in helping these people to save for their retirement," Mr. Ameriks said.
Overall Strong Comprehension of Changing Allocation and Risk
A vast majority of the "aware" participant TDF holders understood the fundamental goal and design of the funds, acknowledged that they involve risk, and accurately reported that they offer no guarantees. Other key participant findings were:
- 77% knew that the asset allocation becomes more conservative as the target year approaches, showing an understanding of these funds' changing asset allocation.
- 68% recognized that target-date funds offer a diversified mix of stock and bonds. (Diversification does not ensure a profit or protect against a loss in a declining market.)
- 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 that TDFs provide either a guaranteed return or become risk-free at the target date.
Respondents did show some uncertainty about TDF asset allocations at and after the target date. For example, when presented with a list of attributes that target-date funds might possess, only 24% of the participants indicated that the funds' asset allocation will continue to change after the target year. In fact, most TDFs continue to change their asset allocation for a number of years past the target year.
Generally Sound Decision-Making
When asked why they chose target-date funds, 61% of participants said they wanted a balanced portfolio, simplicity, and convenience.
The survey also examined how investors view the role of a target-date fund in their portfolio. While target-date funds are designed to provide broad diversification in a single portfolio, many investors hold other investments along with a TDF. Of the participants holding such a "mixed" portfolio, 56% said 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," Mr. Ameriks said. "The findings indicate a need to continue to provide education about the highly diversified nature of a single target-date fund."
Reasonable Retirement Income Expectations
An assumption implicit in some criticism of target-date funds following the financial crisis was that many investors expect to withdraw all of their money in these funds at the target date. The survey results show otherwise: 75% of participants said they intended to gradually draw down their target-date fund assets.
In addition, the 2008-2009 market declines led some to question whether target-date funds should maintain equity exposure close to and after the target date, therefore creating the potential for greater risk. Yet the survey shows that more than 90% of the respondents plan to have an equity position in their portfolio at retirement, although the planned equity allocations varied.
Major Implications: Leverage Plan Design and Provide Visual Education
The survey results reveal opportunities to leverage participant education and change plan design to better inform any investors, including participants, about target-date funds.
Vanguard's experience has been that many participants more easily understand the mechanics of target-date funds through visual aids. Vanguard recommends that education include illustrations, such as charts and graphs, to effectively show the changing asset allocation of target-date funds before, at, and beyond the target date. For instance, Vanguard's interactive glide path tool enables users to easily visualize a fund's asset allocation among U.S. and international stocks, nominal and inflation-protected bonds, and cash equivalents for each year through a specific fund's stated retirement date and over five years beyond. A graphical representation of the glide path also appears in the funds' prospectuses and educational materials provided to defined contribution plan participants.
More plan sponsors may want to consider making plan design changes, such as automatic enrollment that automatically places participants in target-date funds, or reenrollment, which resets participants' current investments into a qualified default investment alternative such as a target-date fund.
Investments in Target Retirement Funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the work force. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in a Target Retirement Fund is not guaranteed at any time, including on or after the target date.
About Vanguard
Vanguard, headquartered in Valley Forge, Pennsylvania, is one of the world's largest investment management companies. Vanguard manages nearly $1.6 trillion in U.S. mutual fund assets. Vanguard offers more than 170 index and actively managed funds to U.S. investors and more than 60 additional funds in non-U.S. markets. Vanguard provides recordkeeping and investment services to 3.5 million participants and 1,700 plan sponsors in over 2,500 defined contribution plans, and is also a major provider of investment, advisory, and recordkeeping services to defined benefit plans.
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