EBRI Sheds First Light on Asset Allocation by IRA Owners

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.

Second, persons with high account balances are likely to be more sophisticated investors than those with lower account balances, and more likely to understand the importance of diversifying their investments.

Extreme allocations were also more likely in Roth IRAs than in traditional IRAs. Roth owners were far more likely to have 90% of their assets allocated to equities and less than 10% of their assets allocated to bonds and cash instruments. Owners of traditional IRAs and SIMPLE/SEP IRAs, however, were equally likely to use extreme allocations. And owners of rollover IRAs, in contrast to owners of IRAs funded in other ways, were less likely to use extreme allocations and more likely to allocate their resources to bonds and cash.

Roth owners may be motivated by the tax-free growth in their accounts to take extreme risks with their retirement assets than owners of traditional IRA accounts. Roth accounts also are more likely to be utilized by younger investors and are often supplemental to other retirement accounts, which may also contribute to the higher incidence of extreme allocations.

Perhaps surprisingly, equity allocations were very similar for men and women at each age group. Women and men under age 25 had 49.1% and 49.5%, respectively, allocated to equities. At 70+, women had 33.1% and men had 33.6% in equities.

What Does the Study Show? More Advice Needed

The EBRI study presents a singular picture of the trillions of dollars invested through self-directed investment accounts like IRAs. Although many investors are making passable decision on their own, the study shows that there are still outliers in dire need of investing help. Investors using extreme allocations are the most obvious candidates for advice—and they need help regardless of age, gender or portfolio size. Particular attention should be paid to Roth IRAs, where extreme allocations are the most common.

But extreme allocations aren’t the only place investors need financial advice. The average allocations found in the study don’t gel with most advisors’ target allocations. The equity allocation for investors aged 70+ (39.7%) may be too high, and the equity allocation employed by those under age 25 too low (59.6%) for many advisors’ taste. These results illustrate that, although investors aren’t entirely out of the ball park with their self-directed allocations, investors generally still need financial advice to reach their retirement goals.

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