PPA Vision of More Informed Investors Has Progressed

A short series of papers published by Vanguard shows knowledge of investing principles and fund features directly impacts the likelihood of investing success, even in product categories designed to put most decisionmaking in the hands of professionals.

The quintessential example of this product category, at least within the workplace retirement investing domain, remains target-date funds (TDFs). According to Vanguard, TDFs are currently offered by 88% of plan sponsors and utilized by upwards of 64% of participants, due largely to the Pension Protection Act’s (PPA) sanctioning of TDFs as a qualified default investment alternative. It’s not just the PPA driving TDF success, though; about half of individual target-date investors report having proactively chosen to invest their TDF holdings.

Generally, TDF investors understand how their investments work and say they are familiar with the “outwardly simple, inwardly sophisticated” messaging product providers have stressed in the last year. A strong majority (64%) say they understand the glide path concept of the investment mix getting more conservative over time, while 57% understand TDFs hold both equity and fixed income in a ratio that is rebalanced over time.

These are positive signs, Vanguard says, but the industry is still a long way away from ensuring all participants are picking the right TDF vintage, for example, or that all participants grasp the distinction between to- versus through-retirement funds. A significant number (19%) reported the incorrect perception that TDFs will provide guaranteed retirement income, while 14% said a TDF generally has a guaranteed rate of return/guaranteed growth. Another 12% identified a TDF as “having the same asset mix over time,” while 11% said TDFs become “risk free” after the retirement date.

The Vanguard paper warns the helpful features of TDFs—automatic asset allocation and regular rebalancing, in particular—are not enough to overcome poor investor decisionmaking in these areas. Even participants using TDFs need to understand the pitfalls of too-small salary deferral percentages, overactive trading, loans/leakage, etc. 

NEXT: Risk understanding improves among participants

Another interesting trend reported by Vanguard is a strong acknowledgement by investors that TDFs carry potentially significant risk. Nearly eight in 10 (78%) agreed that TDFs carry at least “some investment risk,” with about half of this group suggesting TDFs carry moderate or significant investment risk. 

Also encouraging is that participants increasingly understand that specific TDF providers will vary on their glide path recommendations, but that in general equity exposure should be reduced over time to prevent dramatic portfolio losses immediately prior to retirement. In other words, they are coming to understand the connection between TDFs' glide path approach and the importance of addressing sequence of returns risk within an individual's retirement portfolio.

Looking to the back-end of the glide path, there is an ongoing need for education and innovation. TDF investors broadly expect employer-sponsored retirement plans to be their primary source of retirement income—including a majority of investors planning “to take systematic withdrawals or spend their savings as needed in retirement.” The last several years have brought significant innovations in the area of in-plan income, Vanguard notes, but most plans are still simply not prepared to help participants effectively control their retirement spending. 

Vanguard concludes plan participants are, in effect, seeking “through-retirement” products, something for plan sponsors and advisers to keep in mind when selecting or reviewing products in the new year.

Vanguard partnered with Greenwich Associates to conduct the underlying participant survey and associated TDF reports, which cover both proprietary and non-propriety funds.