More than 25% of all U.S. retirement assets are held in individual retirement accounts (IRAs), but up until now, little data existed on asset allocations within those IRAs. As a result, the retirement prospects of retirees owning IRAs have remained a mystery.
New research from the Employee Benefit Research Institute (EBRI) gives us a first peek into self-directed accounts like IRAs, providing hard data on the investing behavior of account owners and giving us insight into common problem areas in these accounts.
EBRI’s database includes information on 11.1 million individuals’ 14.1 million individual retirement accounts. Assets in the tracked accounts amount to $732.9 billion. Assets are divided into broad categories, including the following: equities, bonds, balanced funds, money funds and other investments (including annuities and real estate).
Are IRA Balances Balanced?
Owners of self-directed investment accounts like IRAs have a freer hand in allocating investments in their accounts than 401(k) investors, but does that mean they are more likely to make unbalanced equity allocations or excessively safe bets that don’t even beat inflation?
One of the most interesting results of the study is that average IRA and 401(k) equity asset allocations are almost identical—despite the fact that the federal government has encouraged safer investment by 401(k) participants. IRA owners thus appear to be cognizant of their need to diversify their investments. According to EBRI, equity allocations (not counting balanced funds) account for 37.4% of the holdings in 401(k) plans and 38.5% in IRAs.
The study concluded that the size of a person’s account balance is the best indicator of their investing habits. As account balance size increases, the percentage of funds dedicated to balanced funds and equities decreases.
For example, when account balances are between $10,000 and $25,000, equities make up an average of 50.4% of account owners’ portfolios, with balanced funds coming in at 20.1 %. In contrast, when account balances are between $150,000 and $250,000, equities make up an average of 37.6% of portfolios and balanced funds come in at 11.7%.
Despite the relative parity between equity allocations utilized by IRA and 401(k) participants, the study did find that extreme allocations—having less than 10%, or more than 90%, of one particular asset—were more common in IRAs than in 401(k)s.
It shouldn’t come as much of a surprise that extreme allocations are much more likely in accounts with very low balances than in accounts with higher balances. This probably reflects a couple of factors. First,
at the low end of the account balance spectrum, transaction costs are prohibitive to diversifying investments. Transaction costs eat a larger portion of smaller account balances, so individuals with low account balances may be motivated to keep trading to a minimum by making just a couple of purchases in their accounts.