The Role DC Plan Investment Menus Play in Participant Savings

A recent analysis by Alight Solutions found retirement plan participants invested in target-date funds (TDFs) are contributing less than those who don’t utilize TDFs.

However, a Vanguard report highlighted the extreme growth among these investment funds—93% of plans associated with the advisory firm have adopted TDFs as of 2018. That same year, TDFs accounted for more than one-third of total Vanguard defined contribution (DC) plan assets and over half of total DC plan contributions.

TDFs’ domination of the total fund landscape lends itself two questions: 1. As the fund increases in popularity, why are more participants contributing less to their retirement, and 2. Are there other funds that, while not as popular, incentivize participants to save more?

Sarah Holden, senior director of retirement and investor research at the Investment Company Institute (ICI), believes contribution rates could be correlated to the use of automatic enrollment. As participants are automatically enrolled into their workplace’s 401(k) upon hiring, some will stick to the default rate, in the classic “set-it-and-forget-it” type of approach.  

“Nine out of 10 participants are in a plan where their employers put money in their account for them, but that depends on how much money [participants are] looking to put in,” Holden explains. “So contribution rates can be affected by auto-enrollment design and employer match.”

According to the Alight report, other causes for reduced savings include the belief that TDF returns will boost savings accumulation related to age among investors. Younger investors are likelier to save less (even if they’re likelier to meet their retirement goals), due to the notion that they will save more as they age. Others who remain full TDF investors may automatically think their returns will heighten their savings.

“People have been told not to pull all their eggs in one basket, and that’s what a TDF looks like to them,” said Rob Austin, head of Research at Alight Solutions, at the time the report was released. “They don’t understand that there’s diversification in underlying funds.”

Unlike TDFs, managed accounts are not diversified investment options. Instead, they allow participants to take the wheel on their own investments and are widely catered to the “do-it-yourself” investor. As participants are furthering their engagement with retirement accounts and investment options, can managed accounts persuade participants to save more?

It’s possible. A 2018 Alight Solutions analysis found employees who had consistently utilized managed accounts were more regularly adding contributions. The average contribution rate for managed accounts was 8.5% while TDFs only accounted for 6.1%, with 75% of managed account users consistently making contributions over a five-year horizon. Sixty-one percent of TDF users had continuously made active contributions.

At least one study has shown that a bigger core investment lineup is favored among DC plan participants. A new Morningstar study finds that participants in plans with larger core menus and who built their own lineups had more effective portfolios. Those participating in plans with 30 funds invested in an average number of 8.6 holdings.

“Large core investment menus appear to have the dual benefit of nudging more participants to use the default-investment option while getting self-directed participants to build more-efficient portfolios. When it comes to core menus, bigger is better,” the report says.

The Morningstar survey suggests that to raise savings, employers and advisers will need to reevaluate their core menu design, as well encourage participants to make better investment decisions. Holden echoed the same sentiment. Whatever investment path participants decide on—depending on what is offered as well— plan sponsors can maximize savings through their offerings.

“Ask yourselves what retirement savers are looking at in terms of their range of choices, and then what choices they are making,” she says.