More Than Half of 401(k) Participants Are in TDFs

According to the report “Target-Date Fund Adoption in 2013,” 55% of all participants held a position in TDFs, and TDFs accounted for one-third of total plan contributions. In addition, 86% of 401(k) and other defined contribution (DC) plans at Vanguard offer a TDF.

The growing popularity of TDFs has affected the level of risk many participants take with their plan investments, according to the paper. For instance, in 2013, 23% of “do-it-yourself” investors held portfolios at either end of the equity risk spectrum. Ten percent held no equities, thus forgoing the potential return benefits of equities, and 13% held only equities, thus overexposing themselves to the higher risk associated with equities. Those figures contrast with the much riskier behavior seen 10 years ago in 401(k) plans, when 13% of participants held no equities and 22% were entirely invested in equities.

“Target-date funds continue to reshape investment patterns in DC plans in fundamental ways. These funds provide appropriate levels of risk as a participant ages and a remedy to the problem of extreme asset allocations,” says Jean Young, author of the report and a senior analyst with the Vanguard Center for Retirement Research in Valley Forge, Pennsylvania. “For these reasons, we expect the adoption of TDFs to continue in the coming years.”

Thirty-one percent of all Vanguard participants held a single TDF in 2013, says Young, more than double the figure from five years earlier. Among participants entering the plan for the first time, two-thirds were invested in a single TDF.

According to the report, about half of TDF investors at Vanguard are considered “mixed investors,” meaning they hold a TDF in combination with other investments. In 2013, 46% of all TDF investors fell in this category. Of those, about half became mixed investors as a result of plan sponsor decisions, including employer contributions in company stock or other actions. The other half of mixed investors intentionally constructed a portfolio of both target-date and non-target-date strategies. Many of these participants are pursuing what appear to be reasonable diversification strategies, though they do not fit within the “all in one” portfolio approach of TDFs.

Although many participants choose to invest in TDFs on their own, the paper reveals a major factor influencing the rise of these funds is their use as a default investment in automatic enrollment plans, in which companies sponsoring workplace retirement plans automatically put employees into their plans and invest their accounts in TDFs. By year-end 2013, 34% of Vanguard plans—covering nearly 60% of all participants—had adopted automatic enrollment, typically for participants newly eligible to take advantage of their plan.

Regardless of whether they use automatic enrollment, the analysis shows 81% of all Vanguard plans used a target-date or balanced fund as a default investment by the end of 2013.

More information about the paper is available here.