The Myth About Target Date Fund Participant Inertia
The success of a target date fund (TDF) depends not only on asset allocation, market environment, and manager skill, but also on participant behavior. Are TDF investors truly inactive, as the industry believes, even during periods of market volatility? This paper challenges long-held assumptions about participant inertia and encourages plan fiduciaries to reconsider whether high-equity TDFs are prudent for investors nearing retirement.
#1 – THE MYTH ABOUT TARGET DATE FUND PARTICIPANT INERTIA
The prevailing belief about TDF participant behavior is that these investors are generally inactive through market downturns. As the story goes, any market losses will be on paper only, which participants could fully recoup as markets recover.
#2 – IN MARKET DECLINES, OLDER INVESTORS SELL RISK
Our research shows that, in fact, older TDF investors were not inactive in the pandemic-triggered market correction in early 2020 nor during the Global Financial Crisis in 2008-2009. They sold out of their TDFs and suffered actual—not paper—losses, impairing their chances of recovery and threatening successful retirement outcomes.
#3 – WHY OLDER PARTICIPANTS JUMP SHIP IN MARKET DECLINES
When retirement plan participants lose their jobs and are forced to retire earlier than they anticipated, they are more likely to begin taking retirement plan distributions. For TDF participants, this means selling out of their TDFs to make ends meet in retirement.
#4 – WHY UNDERSTANDING OLDER PARTICIPANT BEHAVIOR MATTERS
Because older participants sell out of their TDFs during significant market declines, they incur losses that can have a substantial negative impact on retirement outcomes. These can include longer recovery times, running out of retirement savings, and living on less to stretch out a smaller nest egg.
Learn more about why participant behavior matters for successful retirement outcomes.
1 TDF net flows, per vintage category, are per Morningstar Direct as of 3/31/2021.
2 Bureau of Labor and Statistics (BLS), 5/31/2020.
The Prudential Day One® target date funds may be offered as: (i) insurance company separate accounts available under group variable annuity contracts issued by Prudential Retirement Insurance and Annuity Company (PRIAC), Hartford, CT, a Prudential Financial company, and (ii) registered mutual funds offered through Prudential Investment Management Services LLC (PIMS), Newark, NJ, a Prudential Financial company. PRIAC is solely responsible for its own contractual obligations and financial condition.
The Day One Funds, as insurance company separate accounts, are investment vehicles available only to qualified retirement plans, such as 401(k) plans and government plans, and their participants. Unlike mutual funds, the Day One Funds, as insurance company separate accounts, are exempt from Securities and Exchange Commission registration under both the Securities Act of 1933 and the Investment Company Act of 1940, but are subject to oversight by insurance regulators. Therefore, investors are generally not entitled to the protections of the federal securities laws.
The target date is the approximate date when investors plan to retire and may begin withdrawing their money. The asset allocation of the target date funds will become more conservative as the target date approaches and for ten years after the target date by lessening the equity exposure and increasing the exposure in fixed income investments. The principal value of an investment in a target date fund is not guaranteed at any time, including the target date. There is no guarantee that the fund will provide adequate retirement income. A target date fund should not be selected based solely on age or retirement date. Before investing, participants should carefully consider the fund’s investment objectives, risks, charges and expenses, as well as their age, anticipated retirement date, risk tolerance, other investments owned, and planned withdrawals. The stated asset allocation may be subject to change. It is possible to lose money in a target date fund, including losses near and following retirement. Investments in the Funds are not deposits or obligations of any bank and are not insured or guaranteed by any governmental agency or instrumentality.
Investing involves risk. Some investments are riskier than others. The investment return and principal value will fluctuate, and shares, when sold, may be worth more or less than the original cost, and it is possible to lose money. Past performance does not guarantee future results. Asset allocation and diversification do not assure a profit or protect against loss in declining markets.
Investments in the Funds are not deposits or obligations of any bank and are not insured or guaranteed by any governmental agency or instrumentality. For investors close to or in retirement, the funds' equity exposure may result in investment volatility that could reduce an investor’s available retirement assets when they are needed. For investors further from retirement, there is risk that a fund may invest too much in investments designed to ensure capital conservation and/or current income, which may prevent the investor from meeting his or her retirement goals.
This material is being provided for informational or educational purposes only and does not take into account the investment objectives or financial situation of any client or prospective clients. The information is not intended as investment advice and is not a recommendation. Clients seeking information regarding their particular investment needs should contact their financial professional.
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1048969-00002-00 Ed. 8/2021