TDFs Decrease 401(k) Investing Extremes

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

The study report, “Target-Date Fund Adoption in 2011,” suggests the rapid growth of target-date fund adoption has also led 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 entire account balances of one-third of all Vanguard participants were invested last year in a professionally managed option—either a single TDF, 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,” said 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 invest 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 entering their plan for the first time investing in a single TDF.  

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

A major factor influencing the rise of TDFs is the automatic enrollment of participants into their plan and the plan sponsors’ decision to choose TDFs 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,” said Young.  

The report can be downloaded from http://www.vanguard.com/tdf2011.