More than half (55 per cent) of the participants in 401(k) retirement plans at Vanguard now hold a target-date fund, giving them a disciplined approach to investment risk-taking that automatically grows more conservative as they age.
It also prevents extremes in asset allocations.
According to Target-Date Fund Adoption in 2013, 86 per cent of 401(k) and other defined contribution plans at Vanguard offered a target-date fund (TDF), 55 per cent of all participants held a position in TDFs, and TDFs accounted for one-third of total plan contributions.
The growing popularity of target-date funds has had a profound effect on the level of risk many participants take with their plan investments. For instance, in 2013 23 per cent of “do-it-yourself” investors held portfolios at either end of the equity risk spectrum; 10 per cent held no equities, thus forgoing the potential return benefits of equities, and 13 per cent held only equities, thus overexposing themselves to the higher risk associated with equities. Those figures contrast with the much riskier behaviour seen 10 years ago in 401(k) plans, when 13 per cent of participants held no equities and 22 per cent were entirely invested in equities.
“Target-date funds continue to reshape investment patterns in DC plans in fundamental ways. These funds provide appropriate levels of risk as a participant ages and a remedy to the problem of extreme asset allocations,” says Jean Young, author of the report and a senior analyst in Vanguard’s Center for Retirement Research. “For these reasons, we expect the adoption of TDFs to continue in the coming years.”
Thirty one per cent of all Vanguard participants held a single TDF in 2013, more than double the figure from five years earlier. Among participants entering the plan for the first time, two-thirds were invested in a single TDF.
About half of TDF investors at Vanguard are considered “mixed investors,” meaning they hold a TDF in combination with other investments. In 2013, 46 per cent of all TDF investors fell in this category. Of those, about half became mixed investors as a result of plan sponsor decisions, including employer contributions in company stock or other actions. The other half of mixed investors intentionally constructed a portfolio of both target-date and non-target-date strategies. Many of these participants are pursuing what appear to be reasonable diversification strategies, though they do not fit within the “all in one” portfolio approach of target-date funds.
Although many participants choose to invest in TDFs on their own, a major factor influencing the rise of these funds is their use as a default investment in automatic enrolment plans, in which companies sponsoring workplace retirement plans automatically put employees into their plans and invest their accounts in TDFs. By year-end 2013, 34 per cent of Vanguard plans—covering nearly 60 per cent of all participants—had adopted automatic enrolment, typically for participants newly eligible to take advantage of their plan.
Regardless of whether they use automatic enrolment, 81 per cent of all Vanguard plans used a target-date or balanced fund as a default investment by the end of 2013.
Investments in target retirement funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date.
