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Recent volatility in the equity markets has caused fear among some politicians and other observers that 401(k) investors may be too aggressively invested. On the other side are some industry experts, such as 401(k) plan sponsors, who fear participants invest too conservatively. But new research from Vanguard finds that target-date funds can "help eliminate both of these extremes in investor behavior and provide participants with a well-diversified portfolio for retirement."
The Vanguard Center for Retirement Research study looked at the behavior of more than 1.24 million participants, including 357,000 who contribute to target-date funds. It found that participants who did not invest in target-date funds tended to exhibit greater extremes in their equity holdings. Some 30 percent held all-equity portfolios, while 16 percent held zero-equity portfolios.
In contrast, the stock exposure of target-fund investors ranged from 40 percent to 90 percent. And the "beneficial effect" of eliminating extreme allocations extended to "mixed investors," who combined target-date funds with other plan investment options. Furthermore, the study found target-date investors decreased their equity allocations by more than 40 percentage points from age 25 to 65.
"Target-date funds help participants adhere to the principles of prudent investing," says Stephen P. Utkus, head of the Vanguard Center. "On the one hand, these funds maintain a positive equity exposure in pursuit of higher long-term returns. On the other hand, they are broadly diversified and reduce equity exposure over time in order to mitigate the risks associated with equity markets."
These findings may help the fund industry going forward, as 401(k) plans find themselves in the "hot seat" with some politicians. In October, in response to the financial meltdown, the U.S. House of Representatives Health, Education, Labor and Pensions Committee held hearings to consider reforms, notes Jim Farley, director of Lord Abbett's Retirement Research Center in a recent report.
A radical plan discussed at the hearings included the possible elimination of the 401(k) deduction and a mandatory contribution of 5 percent of pay (2.5 percent by the employee and 2.5 percent by the employer) to be run by the Social Security Administration.
There is another potential regulation under the Employee Retirement Income Security Act or ERISA that would require numerous point-of-sale disclosures before a retirement plan is adopted or transferred to a new provider. Farley expects that, given the prior and current HELP Committee activities, this retrenchment "should suit the committee just fine and allow it to mandate additional participant disclosures as a trade-off against more draconian changes to 401(k) plans."