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New Analysis Compares Do-it-Myself Investors to Target Date Funds

The Principal compares risk controls in a target date investment option to a do-it-myself approach

August 23, 2012 (Des Moines, Iowa) – Retirement plan participants who hand pick their own mix of investment options are generally exposed to greater risk due to reduced diversification and a tendency to not automatically adjust their portfolios over time, according to new research from The Principal Financial Group®.

In analyzing a subset of 2.4 million defined contribution accounts[1], The Principal compared do-it-for-me participants who use a target date investment option with do-it-myself participants who select their own allocation and services.

The research found that generally, do-it-myself participants were less diversified by asset class and number of investment options,  rarely used automatic rebalancing to meet their investment goals, and at younger ages, frequently had much less exposure to equities.

Diversification

Do-it-myself participants tended to be less diversified compared to those who select one target-date investment option. The research showed that do-it-myself participants are using an average of two to four investment options across the board, compared to the average 15-20 underlying investment options, representing a variety of asset classes, within the typical target date portfolio[2].

“It’s clear that left to their own devices, participants often don’t fully understand the importance of diversification,” said Jeff Tyler, portfolio manager, Principal LifeTime Funds. “We believe a minimum of five asset classes should be used with a broad selection of investment options to provide adequate diversification for the typical retirement plan participant. The research shows that many do-it-myself investors aren’t meeting that mark. While asset allocation doesn’t assure a profit, target date portfolios seek to accomplish this goal by providing access to multiple underlying investment options and investment managers within a single investment option.”

Asset Allocation

Among the youngest investors analyzed, those opting for a do-it-myself approach generally had less exposure to equities, and may be missing out on one of the key ingredients to greater retirement savings – the potential power of compounded earnings.

Equity exposure among do-it-myself investors who are far from retirement tended to differ significantly from the average target date investor in the same age group[3]. The average do-it-myself participant born after 1987 had nearly 30 percentage points lower equity exposure (54.7 percent) within their investment portfolio compared to the 83.95 percent within a target date investment option.

“Younger investors have a longer time horizon for investing with opportunity to ride out the fluctuations in the market – and therefore a higher tolerance for the risks that come with exposure to equities in their investment portfolios,” said Tyler. “Taking advantage of compounded earnings from a young age is a potential driver to a financially successful retirement.”

Automatic Rebalancing

With time, participants’ investment allocations may become out of alignment with their goals. While participants may rebalance on their own to realign their allocations to their intended strategies, the analysis found that do-it-myself participants are rarely selecting automatic rebalancing.

In fact, research showed that only two percent of do-it-myself investors[4] elected an automatic rebalancing service. Auto-rebalancing is typically a built-in feature within target date investment options.

“We found that do-it-myself investors are rarely taking the important step of selecting auto- rebalancing services to keep their portfolios at the risk tolerance level they selected based on their time horizon. Auto -rebalancing is another step to take the emotion out of investing, to avoid negatively reacting to volatile markets,” said Tyler.

Hear Jeff Tyler discuss some of the features of Principal LifeTime portfolios: www.principal.com/targetdate.

For more news and insights from The Principal, connect with us on Twitter at http://twitter.com/ThePrincipal.

Methodology

This research was based on a subset of 2.4 million participants of The Principal, of which:

  • This research only takes into account the participants’ assets within the defined contribution (DC) retirement plan serviced through The Principal. It does not consider any additional assets these participants may have and how any such assets may factor in to their goals for and asset allocation decisions on the retirement plan assets.
  • Approximately 744,000 were target date investment options users (do-it-for-me). Target date investment option users were defined as participants with assets solely in target date investment option made available by The Principal.
  • Approximately 877,000 were do-it-myself participants, defined as participants with no assets in any target date investment option made available by The Principal.
  • Participants who have some assets in a target date and/or target risk investment option, as well as any participant using an asset allocation service or advisory program made available by The Principal were excluded from the analysis.
  • The average equity exposure for each target date category, according to each specific age band, was compared against the combined total across the following asset classes as categorized by Morningstar’s US Open Ended Mutual Fund category: “Employer Security”, “International Equity”, “Large US Equity”, and “Small/Mid US Equity”. Target date funds that invest in individual securities (rather than funds of funds) were excluded, as well as those target date funds that invest primarily in another underlying asset allocation option.

About Principal LifeTime Portfolios

The Principal LifeTime portfolios, which are target date portfolios, invest in underlying Principal Funds, Inc mutual funds. Each Principal LifeTime portfolio is managed toward a particular target (retirement) date, or the approximate date the participant or investor starts withdrawing money. As each Principal LifeTime portfolio approaches its target date, the investment mix becomes more conservative by increasing exposure to generally more conservative investment options and reducing exposure to typically more aggressive investment options. The asset allocation for each Principal LifeTime portfolio is regularly re-adjusted within a time frame that extends 10-15 years beyond the target date, at which point it reaches its most conservative allocation. Principal LifeTime portfolios assume the value of the investor's account will be withdrawn gradually during retirement. Neither the principal nor the underlying assets of the Principal LifeTime portfolio are guaranteed at any time, including the target date. Investment risk remains at all times.

About the Principal Financial Group

The Principal Financial Group® (The Principal®)[5] is a global investment management leader including retirement services, insurance solutions and asset management. The Principal offers businesses, individuals and institutional clients a wide range of financial products and services, including retirement, asset management and insurance through its diverse family of financial services companies. Founded in 1879 and a member of the FORTUNE 500®, the Principal Financial Group has $367.1 billion in assets under management[6] and serves some 18.2 million customers worldwide from offices in Asia, Australia, Europe, Latin America and the United States. Principal Financial Group, Inc. is traded on the New York Stock Exchange under the ticker symbol PFG. For more information, visit www.principal.com.

Investors should carefully consider mutual fund’s investment objectives, risks, charges, and expenses prior to investing. A prospectus, or summary prospectus if available, containing this and other information can be obtained by contacting a financial professional, visiting principal.com, or calling 1.800.547.7754. Read the prospectus carefully before investing.

Investment options are subject to investment risk. Shares or unit values will fluctuate and investments, when redeemed, may be worth more or less than their original cost. Additionally, there is no guarantee these investment options will provide adequate income at or through retirement.

No investment strategy, such as diversification, can guarantee a profit or protect against loss in periods of declining values.

Investing in real estate, small-cap, international, and high-yield investment options involves additional risks. Each portfolio is weighted to reflect a targeted level of risk. Over time, the weights are adjusted based on predetermined formulas to reduce the level of potential risk as the portfolio's maturity date approaches.

Equity investment options involve greater risk, including heightened volatility, than fixed-income investment options. Fixed-income investment options are subject to interest rate risk, and their value will decline as interest rates rise.

Fixed-income and asset allocation investment options that invest in mortgage securities are subject to increased risk due to real estate exposure.

Separate Accounts are available through a group annuity contract with Principal Life Insurance Company. Insurance products and plan administrative services are provided by Principal Life Insurance Company, a member of the Principal Financial Group, Des Moines, IA 50392. See the group annuity contract for the full name of the Separate Account. Certain investment options may not be available in all states or U.S. commonwealths. Principal Life Insurance Company reserves the right to defer payments or transfers from Principal Life Separate Accounts as permitted by the group annuity contracts providing access to the Separate Accounts or as required by applicable law. Such deferment will be based on factors that may include situations such as: unstable or disorderly financial markets; investment conditions which do not allow for an orderly investment transaction; or investment, liquidity, and other risks inherent in real estate (such as those associated with general and local economic conditions). If you elect to allocate funds to a Separate Account, you may not be able to immediately withdraw them.

Separate Accounts are available through a group annuity contract with Principal Life Insurance Company. Insurance products and plan administrative services are provided by Principal Life Insurance Company. Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc. Securities are offered through Princor Financial Services Corporation, 800.547.7754, Member SIPC and/or independent broker/dealers. Securities sold by a Princor Registered Representative are offered through Princor®. Principal Funds Distributor, Princor and Principal Life are members of the Principal Financial Group®, Des Moines, IA 50392.  Investment options may not be available in all states or U.S. commonwealths.

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[1]
All account values as of 12/31/2011
[2]
The target date funds which participants in our analysis directed their contributions to utilize a fund-of-funds approach
[3]
Assumed Target Date 2051+
[4]
877,000 were do-it-myself participants
[5]
“The Principal Financial Group” and “The Principal” are registered service marks of Principal Financial Services, Inc., a member of the Principal Financial Group.
[6]
As of June 30, 2012.

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