From the May 2012 issue of Research Magazine • Subscribe!

April 25, 2012

Target-Date Funds Dominate 401(k) Plans

Close to one in four 401(k) investors have their assets allocated solely in target-date funds — a six-fold increase over the past five years, according to new Vanguard research. Plus, adoption among new investors is quite strong, with 64% of employees entering their plan for the first time investing in a single target-date fund (TDF).

The recent Vanguard report, “Target-Date Fund Adoption in 2011,” found that 82% of defined contribution (DC) plans at Vanguard offered a TDF last year. Moreover, among all DC plans at Vanguard, 47% of investors had a position in TDFs, with 24% of investors holding assets concentrated in a single target-date fund.

The funds accounted for 27% of total plan contributions. A major factor influencing the rise of TDFs is the automatic enrollment of investors and the plan sponsors’ decision to choose target-date funds as the default investment option. Still, about half of investors make a decision to allocate their savings into TDFs 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 Jean Young, the study’s author and an analyst in Vanguard’s Center for Retirement Research, in a press release.

In 2011, 18% of Vanguard participants held “extreme” or concentrated allocations — 10% with only equities and 8% with no equities. In contrast, when 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. (Target-date investors cannot hold extreme positions because target-date options include both equity and fixed income asset classes.)

Among pure target-date investors, virtually all have equity allocations ranging from 51% to 90% of their portfolios. A large group of pure target-date investors has equity allocations in the 81% to 90% range. This phenomenon reflects two facts, Vanguard says: (1) automatic enrollment into target-date funds, which typically applies to newly eligible plan participants, who are disproportionately under age 40, and (2) in voluntary enrollment plans, a single target-date fund is a popular strategy among new hires.

Target-date funds continue to reshape investment patterns in DC plans in fundamental ways, Vanguard strategists and researchers believe, with three factors driving their growing use by plan sponsors and participants: their simplified approach to investment decision-making and portfolio construction, the growing use of automatic enrollment, and their designation as a qualified default under the Pension Protection Act of 2006.

The fund giant also says that target-date fund adoption by Vanguard-plan sponsors accelerated from 13% of plans in 2004 to 82% of plans in 2011. While introduced only within the last decade among Vanguard plans, target-date strategies accounted for 14% of total plan assets by 2011. 

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