TDFs Decrease 401(k) Investing Extremes

In 2011, 18% of Vanguard retirement plan participants held extreme asset allocations—10% held only equities and 8% held no equities.
Reported by Rebecca Moore

In contrast, when target-date funds (TDFs) first became available in Vanguard plans in 2004, 35% of Vanguard participants held extreme allocations—22% invested in equities only and 13% percent did not invest in equities at all, according to a Vanguard study.

The study “Target-Date Fund Adoption in 2011” suggests the rapid growth of target-date fund adoption has also led to the increasing use, overall, of professionally managed account options, in which a fund manager or third-party adviser makes portfolio-allocation and rebalancing decisions on behalf of participants. The complete account balances of one-third of all Vanguard participants were invested last year in a professionally managed option—either a single target-date fund, a single traditional balanced fund or a managed account advisory service.

Vanguard expects continued growth in professionally managed options. “In five years, Vanguard estimates that 55% of all participants and 80% of new participants will be invested in a professionally managed option,” says Jean Young, the study’s author and an analyst in Vanguard’s Center for Retirement Research.

TDF Use Continues to Grow

Nearly one in four 401(k) participants invests solely in TDFs—a six-fold increase over the past five years, according to the Vanguard research. Adoption among new participants is considerably higher, with 64% of employees who are entering a plan for the first time investing in a single target-date fund.

“Target-Date Fund Adoption in 2011” shows 82% of defined contribution (DC) plans at Vanguard offered a target-date fund last year. Moreover, among all defined contribution plans at Vanguard, 47% of participants had a position in target-date funds, with 24% of all partic­ipants invested in just one of these funds. The funds accounted for 27% of total plan contributions.

A major factor influencing the rise of target-date funds is the automatic enrollment of participants into their plan and the plan sponsors’ decision to choose this type of fund as the default investment option, although about half of participants investing in them make that decision voluntarily.

“We view this trend as extremely positive, because TDFs are providing an increasing number of participants who are neither engaged nor sophisticated investors with balanced, well-diversified portfolios, as well as reducing the risks associated with extreme equity allocations,” says Young.