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A lot of people tend to pick targeted retirement funds that end in "zero" rather than "five"—and that could be a costly mistake, according to a new study.
The study, published online in the Journal of Consumer Research, found that this so-called "zero bias" affects the amount people contribute to their retirement savings and can lead to an investment portfolio with an incompatible level of risk.
According to the study, individuals born in years ending in zero through two select TRFs that imply they intend to retire at 70, while those born in years ending in eight and nine choose TRFs that imply retiring at 60 (in other words, TRFs that mature earlier than they actually intend to retire). The latter group tends to end up worse off financially, while the former end up better off so long as they aren't risk averse.
The reason? The zero bias impacts the amount people contribute to retirement savings and can lead to an investment portfolio with a level of risk that does not match up with their stage of life, which can take a sizable bite out of a person's retirement wealth.
"The evidence is consistent that the bias is an outcome of people using imprecise arithmetic, specifically rounding up and down in the computational estimation required to estimate their retirement year," the study's abstract said.
The study was conducted by Wei Zhang, Kingland Faculty Fellow in Business Analytics and associate professor of marketing in Iowa State University's Ivy College of Business, and co-authors Ajay Kalra, Rice University; and Xiao Liu, New York University. The team analyzed data from a global financial investment firm that included 84,600 individual accounts, nearly half of which invested in targeted funds.
"Targeted funds offer a 'set it and forget it' approach to investing, which is popular for consumers who don't want to navigate financial decision-making," Zhang said in a press release. "However, that initial decision of selecting a targeted plan has implications."
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Zack Needles
Zack Needles is Global Managing Editor, Regional Brands at ALM. He is also the Managing Editor of The Legal Intelligencer, Pennsylvania Law Weekly, Delaware Business Court Insider and Delaware Law Weekly. Contact him at 215-557-2373 or [email protected]. On Twitter: @ZackNeedlesTLI.
