If you’re saving for retirement through a target-date fund, chances are you’re doing it incorrectly.
A new survey from investment advisory firm Financial Engines finds that only 25% of people who invest in target-date funds are using them as intended, holding all (or nearly all) of their investments in such funds, and leaving them there for the long haul. These investors tend to be younger and less confident in their decisions; most have been defaulted into the funds, which allocate assets based on one’s age and projected retirement date.
But as investors get older and build up higher balances, nearly two-thirds decrease their holdings in target-date funds, and some drop out all together. That decision could cost them. According to Financial Engines, a “partial target-date fund approach” can result in annual returns that are 2.1% lower than staying fully invested.
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Why do people move away from these “set-it-and-forget-it” funds? The most common reason is overconfidence: 62% believe that they can achieve better returns by investing on their own, despite evidence to the contrary. Another common reason, cited by nearly two-thirds of participants, is wanting more diversity and “to avoid putting all their eggs in one basket.” That despite the fact that 81% of users understood that target-date funds already are diversified. The report suggests that investors may be seeking even greater diversification across investment funds or asset managers. They also might want a higher level of personalization than target-date funds offer. Either way, the report concludes, the failure on the part of employers to address these needs is a “potential flaw” in successful workplace retirement plans.
That’s not to say target-date funds are a magic elixir for a secure retirement, though 401(k) plan providers are increasingly auto-enrolling workers into them. The fact that the funds only take into account your projected retirement date means they can’t be customized for your personal circumstances and risk tolerance. They also may come with higher fees that can take away a big portion of your nest egg over time.
So how can you be sure you’re making the best investing decisions for retirement? For starters, understand your plan: The study also found that 10% of participants were unsure if they had fully invested in a target-date fund or not. Look at your company’s target-date funds for employees on the brink of retirement to get a handle on how risky your portfolio might look in the future. And while you shouldn’t check your retirement portfolio too often, neither should you get complacent. Keep an eye on the best-performing funds to make sure your money is working as hard as it can for you.