Mixing target-dates with other funds linked with higher savings

People who invest their money in both target-date funds and other products are more financially prepared than those who hold target-date funds alone, but not because they are better at investing, data from a recent report show.

They are just better savers, in most cases.

On average, people who invest in both target-dates and other funds have a projected income-replacement ratio in retirement of 89.6%, and 58.8% of those people will be able to replace at least 70% of their preretirement earnings, according to a new paper from John Hancock. For people who invest only in target-date funds, those figures are lower, at 84.8% and 51.7%, respectively. The numbers are based on data from John Hancock’s defined-contribution business.

Although those figures seem to paint a compelling picture, the company does not advocate mixing target-date funds and other investments. Doing so often puts investors’ overall allocations in higher or lower risk levels than are ideal, as target-date funds are intended to be all-in-one investments, the company noted.

“However, the evidence seems to show that with appropriate education and guidance, participants can potentially have success with a ‘TDF-plus’ approach to asset allocation,” the paper from John Hancock read.

IT’S NOT WHY YOU’D THINK

It might be tempting to think that individual investors often succeed when striking out on their own, putting savings into funds beyond the target-date products — but that is generally wrong, said David Blanchett, head of retirement research for Morningstar Investment Management.

People who save outside of their target-dates are also more likely than others to be actively involved with their retirement plans, meaning that fewer of them stick with the default contribution rates assigned to participants who are automatically enrolled in 401(k)s.

“There’s a ton of research that shows that, on average, people don’t do a great job of investing. But where we have a problem with 401(k)s today is not investing — it’s the savings rates,” Blanchett said.

For example, plans often set the default contribution rates at 6% or less, which is hardly adequate to help people prepare for retirement.

Savers who invest in individual funds outside of their target-dates are generally better off not because of superior investment acumen — they’re just better at putting money into their accounts, Blanchett said.

If self-directed investing leads people to contribute more to their plans, that is good, but most of those savers would be better off contributing at the same high level and funneling it all into target-date funds, he said.

“If you’re going to self-direct your portfolio, I want as much of that in a target-date fund as possible,” Blanchett said. “I don’t want someone to take away from this that people should do mixed investing because it will lead to better outcomes.”

HOW PEOPLE USE TARGET-DATE FUNDS

About 78% of people in 401(k) plans invest in target-date funds, and 54% of participants use those products exclusively, data from Vanguard’s How America Saves 2020 report show.

Those investors are more likely to be younger, lower-wage workers who are automatically enrolled in their companies’ retirement plans and thus defaulted into the products.

The story is different among retail clients, only about 20% of whom invest in target-date funds, according to a separate Vanguard report, How America Invests.

“Despite the fact that TDFs are designed as all-in-one retirement portfolios, most TDF-using households also hold other types of investments,” that December report noted. “Pure TDF investors — those investing exclusively in a single TDF — are almost exclusively from individual retirement account (IRA) only households.”

The median allocation to equity among self-directed investors ages 75 to 90 is nearly twice as high as those invested solely in target-date funds, although the risk levels assumed by DIY investors varies widely, the report found. Overall savings were also higher among people who mix target-date funds and other investments, at a median of nearly $111,000, versus a median account balance of $16,000 for target-date-only investors.

Vanguard also found that target-date investors, regardless of their overall allocations, are less likely to make trades than other clients. Those holding individual securities and ETFs are more than three times as likely to trade than other investors, while target-date users are slightly less likely on average to engage in trading, likely because the products automatically adjust their allocations, according to the company.