Target date funds (TDFs), the most popular 401(k) qualified default investment alternative (QDIA), were designed to meet the investment needs of typical plan participants, no matter what their age. The theory is that employees can essentially “set it and forget it,” as TDF portfolios are automatically adjusted from aggressive to more conservative as employees approach and proceed through retirement. That theory, however, has been challenged by research pointing to participants’ failure to use TDFs as intended.

Out of balance
Because TDFs are designed to give retirement investors an appropriate asset allocation, in principle, plan participants may want to consider investing their entire portfolio in the age-appropriate TDFs. But research has demonstrated that participants often consider TDFs as a more singular investment that needs to be supplemented by other funds, to avoid “putting all their eggs in one basket.”

That becomes a problem if, for example, 35-year-old participants whose optimum retirement portfolio allocation should be 80% stocks and 20% bonds have half of their retirement portfolio in a TDF with that allocation, and the remaining 50% in bond funds. The resulting aggregate picture would be a 40/60 stock/bond allocation.

How big a problem is this suboptimal use of TDFs? As long ago as 2009, the Employee Benefit Research Institute (EBRI) was raising concerns about the matter. The EBRI Notes publication it issued in December of that year called attention to an emerging “new class of 401(k) investor” that it dubbed the “mixed TDF investor.” Its study concluded that “some mixed TDF investors apparently fail to understand either the purpose or the benefit of a TDF,” which could result in “ending up with a potentially inferior portfolio.”

The phenomenon can be blamed, to some extent, on inertia — when a TDF became available, participants who started contributing to it simply may have left their prior investments in place. Other research by Financial Engines (an investment management firm) has raised another concern: The same inertia that’s fueling the “mixed TDF investor” phenomenon is keeping younger participants who began investing exclusively in a TDF from the start from ever considering other investment options several years down the road.

Age-based patterns
The study by Financial Engines found significant correlations between participant age and TDF investment patterns. Younger participants with smaller accounts are much more apt to have all their 401(k) assets in TDFs. This equals 10% of total plan assets. This means that 90% of defined contribution plan assets aren’t benefiting from use of TDFs, even with widespread default usage as a QDIA.

So why are participants moving out of TDFs or never investing fully in them to begin with? According to the research, participants are looking to diversify more than just their investments and seem to be seeking diversification among investment managers and among funds.

This indicates something different from a lack of plan participant understanding of the principles of TDF investing that plan sponsors can remedy through a more robust education program. It points to the possibility of a design flaw that may limit TDFs’ long-term ability to meet the needs of midcareer participants with average-size accounts.

While younger participants with small account balances may be well served by TDFs, older participants with more substantial account balances and complex financial situations might not be, due to the “one-size-fits-all” age-based structure of the typical TDF.

Managed accounts as QDIA
So how to use a QDIA for older participants? Managed accounts featuring participant access to professional investment advice and customized investment solutions could be more suitable for this group. Financial Engines, which is a provider of managed account funds, researched this question. Specifically, it compared investment results of TDFs with those of managed accounts, by five-year participant age brackets.

The study concluded that median returns from managed accounts and TDFs were the closest for the youngest and oldest participants, and the most divergent (with superior results for managed accounts) for participants in five-year age brackets between 35 and 55.

What’s noteworthy about this finding is that employees in that 20-year middle age bracket generally have more dollars to contribute to a 401(k) plan than younger employees, and a greater time horizon before retirement than older employees. That means that achieving the best possible investment returns for that group will have the greatest impact on the ultimate size of their 401(k) portfolios at retirement.

What to do next
So what’s the meaning of all this? This doesn’t suggest that plan sponsors should rush out and reinvent their QDIA strategy. However, it does raise questions about whether the category of QDIAs should be uniform across all participant age brackets. Talk with your employee benefits specialist and financial advisor to learn more.

BPM is one of the largest California-based accounting and consulting firms, ranking in the top 50 in the country. It has served the San Francisco Bay Area's emerging and mid-cap businesses, as well as high-net-worth individuals, since 1986. Our Employee Benefits team consists of professionals with extensive knowledge of ERISA guidelines and deep expertise performing employee benefit plan audits. We can help you craft a smooth-running plan that serves your employees while mitigating associated risk. For more information or for a free expert consultation, contact Jenise Gaskin at (925) 296-1016, Michelle Ausburn at (707) 524-6588 or visit us at

Jenise Gaskin - CPA - Advisory

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