Target-Date Funds Have Normalized Workers’ Equity Allocations

The rise of target-date funds in retirement investing is making equity allocations by workers less extreme, new Vanguard Group research shows.

The rise of target-date funds—and automatic features, following passage of the 2006 Pension Protection Act—has boosted retirement plan participation rates, employee deferrals and account balances and influenced employees to sharpen age-appropriate investment allocations to equities, argues the research paper, “Generational changes in 401(k) behaviors,” from Vanguard.

Workers have shifted from the extreme equity allocations—defined by Vanguard as entirely allocated to equity or holding zero equity—since 2006, says Dave Stinnett, a principal and head of strategic retirement consulting at Vanguard.

“In 2006, [extreme allocations] used to be a decent percentage of the population of 18-to-24-year-old’s,” Stinnett explains. “Over time, courtesy of the popularization of target-date funds, that’s really been solved for, and that was something that we spent a lot of time in the late 90s and 2000s talking to plan sponsors about.”

In 2021, among Generation Z employees ages 18 to 24 in automatic enrollment plans, 3% held portfolios with extreme allocations to equities, compared to 13% in 2006. In 2021, 8% of Baby Boomers ages 57 to 70 in automatic enrollment plans held extreme portfolios, compared to 36% in 2006, research showed.

Prior to the PPA passing, younger workers in particular “would start off start off [investing] way too conservative and then eventually, by their mid-30s, they would ramp up to where they should be [allocated], but they would miss out on 10 to 15 years of optimal equity allocation,” Stinnett says. “That’s really been solved for, the data shows, [because] If you’re defaulting people into the plan and defaulting them into target-date funds, they’re starting off where they need to be, and then they’re having that [investment risk] decline as they get older, [in a glidepath] out of equities.”

Target-date funds have become the prevalent qualified default investment alternative for defined contribution plan participants following PPA’s passage.

“That’s [driving] the bulk of it,” Stinnett says. “It proves out that defaults and automatic features work, and they work dramatically, or the most [effectively] for the youngest age cohorts.”

The shifts for workers away from extreme equity allocations are a clear result, Stinnett says

“It’s something I expected to see, but not to the degree to which you see it’s been cured,” Stinnett adds.

In 2006, regardless of workers’ age, median equity allocations for every age cohort examined were significantly similar, data showed, despite younger workers having more years to prepare for retirement.

In 2006, median participant-weighted equity allocations have shifted for the age cohorts of Generation Z (18 to 24); Millennials (25 to 40); and Gen X (41 to 56), Vanguard found.

The oldest cohort, Baby Boomers (57 to 70), held a 70% equity allocation in 2006, and the “spread between the youngest and oldest cohorts was only 11 percentage points,” the paper stated. “In 2021, the difference in the equity allocation held by each generation was much sharper.”

In 2021, Generation Z and Millennials had a median equity allocation of 89%, compared with 61% to 65% for the boomers—based on whether participants were subject to automatic enrollment—a 24%-to-28% spread, Vanguard data showed.

The research paper was authored by Jeff Clark, a senior product owner, and Kevin Kukulka, a data analyst, at Vanguard.  

Data sources for the paper included 219 defined contribution plans representing 250,000 employees offered by the same set of companies in both 2006 and 2021, according to a spokesperson. The methodology compared cohorts based on their ages in 2006 and 2021.