Employees don't understand target date funds, and that could spell trouble for employers.
Employees don't understand target date funds, and that could spell trouble for employers.
Less than 6% of employees surveyed by Chicago-based Envestnet Asset Management Inc. and Evanston, Ill.-based Behavioral Research Associates LLC had heard of the funds and could correctly describe them.
Among the more glaring misconceptions:
• Nearly 62% of respondents thought that they would be able to retire on the fund's target date.
• Almost 38% of respondents thought that the funds would produce a guaranteed return.
• More than one-third of employees thought that their money would grow faster in target date funds than in other investments.
• Almost 30% said thought that the funds permitted them to save less money while still meeting their retirement goals.
“Target date funds are diversified portfolios with risk-appropriate management as you get closer to retirement. That's what they do — there is no guarantee,” Michael C. Henkel, managing director of retirement services at Envestnet, said in an interview.
He said that the survey aimed to point out problems in the way that investors perceive target date funds.
“We have been arguing that by providing outcome-oriented reporting, many of the problems, including the risk issues raised in the last several months, can be mitigated,” Mr. Henkel wrote later in an e-mail.
Envestnet, a consultant to advisers and institutions, has developed an “advice and guidance service” — an online retirement calculator — for target date fund managers to put on their platforms.
“We do offer a solution on the outcome reporting,” Mr. Henkel wrote. “However, if outcome reporting were more widely used, it is our belief that participants, plan sponsors and investment managers would all benefit.”
Last year, many funds with 2010 target dates experienced dismal returns; a number of them had equity allocations exceeding 50%. As a result, the Obama administration and Congress now are scrutinizing these investment options.
The problem for employers is that an uninformed participant base could lead to angry participants and lawsuits, according to Josh Cohen, a senior consultant at Tacoma, Wash.-based Russell Investments.
“I think lawsuits are always possible,” he said, noting that he hasn't heard about any lawsuits related to losses in target date funds.
Although poor returns on target date funds can contribute to anger in the work force, “I'm not sure this [anger] wouldn't have happened anyway,” Mr. Cohen said.
“I think one thing last year taught us is that target date funds are not commodities, and they're not all the same,” he said. “[Plan sponsors are] learning that more due diligence is required to truly understand the methodology and the risk profile of the target date fund they hold.”
Of the 251 respondents to the survey, just 16% had heard of target date funds prior to reading a composite description of the funds provided with the survey. Of those who had heard of the funds, 63% described them inaccurately.
POPULAR MYTHS
The survey also uncovered popular myths about target date funds.
Employees had little sense of the risks of investing in these popular funds. For example, 41.4% said that they thought that there was little or no risk of losing money in a one-year period, while 57% said thought it was unlikely that they would lose money in any 10-year period.
Similarly, one-fifth thought that it was less likely that they would lose money in target date funds than in money market funds, while half thought that the odds were equal. Nearly 30% believed that they were less likely to lose money in target date funds than in equity mutual funds, while 52% thought that the odds were the same.
In addition, nearly two-fifths of respondents held that the risk levels in funds with the same target date would be very similar.
And when asked to pick which of seven target date portfolios they would prefer, the majority picked the most aggressive fund, based on expected returns over a 10-year period.
More disturbing, respondents understated the importance of saving. Mr. Henkel noted that just 8% of respondents said that selecting a retirement savings rate was the most important planning decision.
Mr. Henkel, a former president of Ibbotson Associates Inc. of Chicago, said that choosing the right savings rate is “the home run decision you make as an investor.”
By contrast, 28% chose picking the right retirement date, 27% selected picking the fund with the right mix of stocks and bonds that matched the risk they were willing to take, 22% said choosing the fund with the best historical returns, and 15% said picking the fund with the lowest expenses.
Respondents to the survey, which was conducted March 26-31, were between 25 and 70 and were em-ployed or retired.
Timothy Inklebarger is a reporter for sister publication Pensions & Investments.
