Vanguard Sees Increase in Use of Index Fund Investments

The use of low-cost index funds by participants in Vanguard 401(k) plans increased noticeably between 2004 and 2012.

The average participant now invests 60% of his or her account balance in such index funds, according to a new Vanguard study. The study, “Behavioral Effects and Indexing in DC Participant Accounts 2004–2012,” indicates that this percentage has doubled from 30% in 2004, largely as a result of the growing popularity of index based target-date funds.

The study also finds that the assets in actively managed funds and non-indexable assets, such as money market funds, stable value funds and company stock, decreased over that same eight-year period, going from 32% in 2004 to 19% in 2012.

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“The movement to index investing is good news for participants who are obtaining broadly diversified exposure to the market at a low cost, which can ultimately help them accumulate more money for their retirement,” says Cynthia Pagliaro, lead author of the study and an analyst in Vanguard’s Center for Retirement Research, based in Valley Forge, Pennsylvania.

The study highlights a steep drop in the number of participant accounts invested solely in actively managed funds and finds a concurrent increase in all-index accounts. In 2004, 39% of participants were invested exclusively in active funds. By 2012, this all-active group had decreased to 19%, a relative decline of 51%. Conversely, in 2004, 10% of participants were invested solely in index funds. By 2012, that figure was 38%, a nearly fourfold increase.

The study also finds that older, longer-tenured participants held 100% active portfolios, likely as a result of inertia, meaning these participants never changed their investments. This “inertia effect” is common among existing participants, many of whom never alter their initial allocations. Younger, shorter-tenured participants tended to hold 100% index portfolios, largely because they were automatically enrolled in plans with index based target-date funds as the default investment.

Pagliaro and the other authors of the study also examine how participants allocated their ongoing contributions, which are a better indicator of their future investing intentions than the current composition of their accounts. From 2004 through 2012, the percentage of contributions that participants directed to index funds rose from 32% to 64%, while the percentage directed to active funds declined from 38% to 20%.

Another factor influencing participants’ transition to indexed investments is their plan’s investment menu, according to the study. In recent years, more index funds—primarily indexed target-date funds—have been added to plans because of the sponsors’ desire to reduce participants’ investment costs and exposure to active fund risk. The increased prominence of index funds in plan investment lineups has contributed to participants’ increased adoption of these funds. In addition, for participants who want to voluntarily choose their investments, target-date funds can offer a simplified choice because they can be chosen based on the investors’ expected retirement age.

“The results of this study highlight the critical role that plan sponsors play in the investment strategy of participants,” says Pagliaro. “Due to these behavioral effects, it is likely that the sponsor’s decision will have a profound influence on the investment choices made by their participants.”

More information about the study can be found here.

The MEP Revolution

Prediction: Multiple employer plans (MEPs) will grow faster than nearly any other segment of the retirement industry over the next ten years.

Corollary: Advisers and vendors who start MEPs and do a good job overseeing them will grow faster than the competition.

Roughly four years ago, an adviser friend became entranced with MEPs. He thought they sounded cool and that they should play a big role in the future of his business. He wanted help thinking through the business model, thus beginning a collaboration we have both enjoyed immensely. His central focus was finding ways to transfer labor and headaches from employers to his advisory firm, or to vendors; he had identified an unsolved problem and saw an opportunity in building a solution.

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Fast forward to today: this adviser signed up nearly thirty new clients in the past six months using a handful of custom-built MEPs. The moral of the story is that MEPs are the real deal-they have profound advantages and clients instinctively like the sound of them, and because of their uniqueness, MEPs make the sales process easier.

Another anecdote: In 2013, an adviser engaged a marketing firm to make outbound telemarketing calls. This firm is accustomed to spending fifty hours per month generating four to six appointments for an adviser. But using the Pentegra story centered around multiple employer plans, the telemarketer reports spending 35 hours to generate six to seven appointments per month. That’s an 86% increase in the effectiveness of cold calling, and the marketer specifically indicated that the MEP component was the reason, saying, “The messaging is very different from what employers are hearing” in the steady bombardment of calls that every plan sponsor receives.

One more story: An adviser with a relationship with a non-profit association was able to move the association to sponsor a 403(b) MEP for its members (one of very few such plans in the U.S.-this is an exciting and completely untapped market). This arrangement is too new, so the jury is still out, but at a minimum it looks as though this adviser will have a ready base of customers who will adopt right away, and will enjoy a pool of warm leads for years to come. The worst case scenario is that he’ll pick up six clients using the same amount of effort he would normally spend to get ten. The best case is that he will have 100 or more new clients within five years.

MEPs have been around for years (Pentegra’s flagship programs for financial institutions go back to the 1940s) but the notion of applying them to the broader retirement market is relatively new and MEP growth is therefore in its infancy. MEPs fit employers of all sizes, but offer the greatest value boost for smaller employers-roughly 80% of all retirement plans in the U.S. Yet MEPs today have perhaps 2% of the market. Expect that to change. If my opening prediction is correct—that MEPs will grow faster than the rest of the industry—MEPs have the potential to explode in growth.

And those who start them, grow them, and serve them faithfully will prosper.

 

   

Pete Swisher is the author of “401(k) Fiduciary Governance: An Advisor’s Guide,” a textbook for the ASPPA Qualified Plan Financial Consultant credential, and serves as National Sales Director for Pentegra, where he can be reached at pswisher@pentegra.com. 

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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