Factors Influencing Behavior

We conducted a formal statistical analysis of the factors driving pure versus mixed target-date investor status in DC plans, using the first 2008 employee contribution as our preferred measure of behavior.[8]  This analysis suggests that different factors drive target-date adoption, depending on the investor type.

Pure investors are more likely to have lower balances and shorter tenures than other participants and be strongly influenced by a plan's default fund designation (Figure 6, top panel). Mixed investors also are more likely than other participants to be recently hired, but are more active decision-makers than other participants: They are more likely to be registered for Internet access to their accounts and their decision to invest in target-date funds is not linked to the default fund designation (Figure 6, bottom panel). Aside from these characteristics, both pure and mixed target-date investors are otherwise similar to non-target-date participants.

Mixed Investor Characteristics

One of the unanswered questions about mixed investors is why they choose to adopt a mixed strategy. On the one hand, their behavior may reflect naïve decision-making, including:

• Lack of knowledge/financial illiteracy. Participants may fail to understand the purpose of target-date funds as an "all-in-one" portfolio solution.
• Naive diversification. While they may understand that target-date funds are well-diversified, participants may combine them with other funds in a haphazard way, under the naïve assumption that "more is better."
• Inertia. Participants may intend to invest exclusively in target-date funds but fail to rebalance existing holdings to the new approach.

There are also several rational explanations for mixed investor behavior, including:

• Incremental approach. Participants may find target funds appealing but may want to learn more about a fund by investing only part of their portfolio in it.
• Core/satellite approach. Participants may want to "dial up" or "dial down" the risk of their portfolio by adding other fund options to a core holding in the target-date portfolio. These participants might also include actively managed funds in the mix.[9]
• Employer effects. Employer matching or other nonelective contributions may be directed by the employer into a different investment option, such as company stock or a non-target-date default, and so result in a mixed portfolio. Participants may fail to diversify these assets either by choice or inattention.

Without surveying participants, it is impossible to know with certainty which of these motivations plays a role in their decision-making. Indeed, in a large participant population, it is possible to imagine that different combinations of all these factors come into play for different groups of participants.[10] Without survey data, however, we can still attempt to understand the patterns of mixed investor behavior by examining portfolio holdings. Among mixed adopters, we find that:

• The median mixed investor holds four funds, including the target-date fund, and nearly half of mixed investors hold five or more funds (Figure 7).
• The median mixed investor contributes 30% of elective deferrals to the target-date fund. Only 15% of mixed investors are using the target-date fund for more than half of their contributions (Figure 8).
• Mixed investors typically combine the target-date fund with other domestic and international equity options (Figure 9). At the same time, some mixed usage arises because employers are directing money into company stock. Nearly four in ten mixed investors hold company stock, but that is more likely to be caused by employer rather than employee contributions.

In addition, among all mixed investors, 88% hold only one target-date fund. But 12% hold two or more target-date funds, often in addition to other funds.

These results seem to rule out core/satellite as a dominant explanation for mixed investing. The strongest explanations appear to be that participants may be taking an incremental approach or may be naïvely diversifying (holding too many options in addition to the target-date fund or holding multiple target-date funds). Another factor is the role of employer contributions, especially in company stock. Again, additional research will be needed to determine whether mixed investors are employing rational or naive strategies, or both.

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