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Average 401(k) participant invests 60 per cent in index funds, says Vanguard

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The use of low-cost index funds by participants in Vanguard 401(k) plans rose sharply from 2004 to 2012, with the average participant now investing 60 per cent of their account balance in index funds.

The researchers noted that this percentage has doubled since 2004, largely as a result of the growing popularity of index-based target-date funds.
 
The study, Behavioral Effects and Indexing in DC Participant Accounts 2004–2012, also found that the assets in actively managed funds and non-indexable assets, such as money market funds, stable value funds, and company stock, declined significantly over the eight-year period.
 
“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 report and an analyst in Vanguard’s Center for Retirement Research.
 
The study highlighted a steep drop in the number of participant accounts invested solely in actively managed funds, and found a concurrent increase in all-index accounts. In 2004, 39 per cent of participants were invested exclusively in active funds. By 2012, this all-active group had dropped to 19 per cent, a relative decline of 51 per cent. Conversely, in 2004, 10 per cent of participants were invested solely in index funds. By 2012, that figure was 38 per cent, a nearly fourfold increase.
 
The report also found that older, longer-tenured participants held 100 per cent active portfolios, likely as a result of inertia—they simply 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 per cent index portfolios, largely because they were automatically enrolled in plans with index-based target-date funds as the default investment.
 
The researchers also examined 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 per cent to 64 per cent, while the percentage directed to active funds declined from 38 per cent to 20 per cent.
 
Another factor influencing participants’ transition to indexed investments is their plan’s investment menu, according to the report. 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 line-ups 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 report highlight the critical role that plan sponsors play in the investment strategy of participants,” Pagliaro says. “Due to these behavioural effects, it is likely that the sponsor’s decision will have a profound influence on the investment choices made by their participants.” 

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