Remedying the Misuse of TDFs

Defined contribution plan sponsors should provide education in appropriate ways and at appropriate times to help participants understand not only how target-date funds work, but how to select the one that’s right for them.

Target-date funds (TDFs) are designed to take a holistic approach to retirement investing by utilizing all of a participant’s assets within a unified, evolving portfolio, but many investors are still not using these vehicles as they are intended to be used.

According to the latest “Participant Preferences in Target Date Funds” study by Voya Investment Management, only 10% of participants surveyed allocate all their recurring contributions into a single TDF. More participants (11%) are actually only investing 1% to 10% of their contributions into one or more TDFs, while another 10% invest 41% to 50% of their recurring contributions into TDFs.  

When asked why they use TDFs in this (suboptimal) way, the top reason was to add to diversification (45%), suggesting that plan sponsors may need to re-evaluate how they educate participants about the benefits and features of TDFs.

Susan Viston, client portfolio manager with Voya’s multi-asset strategies and solutions team, spoke with PLANSPONSOR to offer some tips. First, she suggests identifying investors in the plan who are deviating from investing all or most of their assets into a single TDFs, before meeting them with targeted communication and educational materials.

She says plan sponsors should provide “clear and engaging participant education and communication around the TDF to help participants understand not only how they work, but how to select the one that’s right for them.” She adds, “We’ve seen a lot of participants not using TDFs the way they were intended, which we believe can lead to sub-optimal risk profiles and sub-optimal retirement outcomes.”

Sponsors need to clearly explain the benefits of having professionally-managed and diversified portfolios that change asset allocation according to a participant’s age as they near retirement. Viston suggests taking a multimedia approach. “You can’t just have one campaign. Use different forums like videos in addition to brochures and letters,” Viston says.

NEXT: TDF basics are needed

Videos and other educational content should briefly explain to participants how a plan sponsor evaluated different providers and why they believe their choice was the best option. Here, sponsors can explain the importance of the series’ investments and the way a TDF glide path is meant to function. Better understanding of these vehicles could not only boost engagement, but also reinstate confidence in investment decisions.  

The survey found that self-proclaimed inexperienced investors, who tended to be younger participants, were the least confident in reaching retirement goals. “I’m a big proponent of multimedia because it’s a way to engage these groups without overwhelming them with the paper materials they’re receiving, or emails they might miss,” Viston says.

Videos can be featured throughout a recordkeeper website, sent to participants via an email link, or even shared on social media channels connected to the plan sponsor

Toni Brown, senior defined contribution specialist with Capital Group, recommends utilizing technology to deliver advice the moment participants set their initial contributions online. She notes that a pop-up window with brief information about TDF best practices could be set to appear when a participant would make allocations that may seem rather odd, like investing in several TDF vintages within a single series.

Viston notes that she’s found participants to invest in as many as ten TDFs within a suite. “That shows a clear lack of understanding TDF strategy,” Viston says. As Brown points out, the extra point of communication may prompt investors to consider whether they truly want to make such a decision.

NEXT: What’s working for TDFs?

According to Voya’s survey, TDF users are more confident about reaching retirement goals and making investment decisions than non-users. More than 75% of respondents said that TDFs reduce the stress of retirement planning, as opposed to 37% for non-users. Voya also found that TDF users contribute a median 2% more of their income toward their accounts than non-users (8% vs. 6%).  

Furthermore, only 34% of non-users reported feeling confident that they were making good investment decisions. This may offer plan sponsors a key opportunity to boost participation levels by effectively communicating the benefits of TDFs to participants across their plans.

“The challenges are inertia, procrastination, and behavioral finance issues that can lead to poor decisions,” Viston says. “TDFs are designed to overcome this, and we’ve seen that they have been able to do that to the participant’s benefit. Participants have continued to contribute to these funds even in times of market stress and decline, meaning they are not selling at the wrong time.”  

The survey, which is the third of its kind conducted since 2011, also found that “simplicity and convenience remain more important than performance.” Auto-enrollment and auto-escalation features can further simplify the process. The firm indicates that both features have become more accepted especially among TDF users, with 76% saying that auto-enrollment would be helpful for employees and 72% saying that auto-increases would be helpful.

Brown suggests that plan sponsors should take advantage of what has been allowed by the 2006 Pension Protection Act (PPA) by offering TDFs as qualified default investment alternatives (QDIA), while also utilizing auto-enrollment, auto-escalation, and re-enrollment every three to five years.

She notes that auto features have been “effective in getting a large number of people into a TDF that’s managed for them. Participants on the whole appreciate it, and there is next to zero push back.”

Still, as Voya’s TDF allocation data has shown, increased participation in TDFs doesn’t necessarily mean investors are using these vehicles to the best of their ability, and there might be overconfidence in TDF use. Plan sponsors need to keep reaching out to TDF users to ensure they are managing their savings effectively even as they near retirement.

“I think that while communication and education is great, it’s not moving the needle as much as we would hope it would,” says Brown. “So, it’s important for the plan sponsor to be very proactive and make sure that employees not only become participants, but successful participants.”