DC Retirement Plan Investment Landscape Is Changed

The industry has made much more headway on improving participant portfolio construction, says Jean Young with the Vanguard Center for Retirement Research.

Vanguard’s 2016 How America Saves report shows the number of defined contribution (DC) plan participants with professionally managed allocations—those who have their entire account balance invested in a single target-date or balanced fund or in a managed account advisory service—has grown.

At year-end 2015, about half of all Vanguard participants were solely invested in an automatic investment program—compared with just 29% at the end of 2010. Forty-two percent of all participants were invested in a single target-date fund; another 2% held one other balanced fund; and 4% used a managed account program. Among new plan entrants (participants entering the plan for the first time in 2015), eight in 10 were solely invested in a professionally managed allocation.

Jean Young, senior research analyst at the Vanguard Center for Retirement Research, and lead author of How America Saves, based in Malvern, Pennsylvania, tells PLANSPONSOR, while automatic enrollment and plan sponsors’ choice of a qualified default investment alternative (QDIA) had something to do with this, the study found more participants chose these options than were defaulted into them. “Just offering the options eases decisions for participants,” she says.

As for the use of managed accounts, Young says the study indicates those who choose managed accounts tend to have higher account balances and be higher-income, longer-tenured employees. “At some point, their balance gets high enough that they want advice and professional investment management,” she notes.

Given the growing focus on plan fees, there is increased interest among plan sponsors in offering a wider range of low-cost passive or index funds. An “index core” is a comprehensive set of low-cost index options that span the global capital markets. In 2015, half (54%) of Vanguard plans offered a set of options providing an index core.

Over the past decade, the number of plans offering an index core has grown by nearly 90%. Because large plans have adopted this approach more quickly, about two-thirds of all Vanguard participants were offered an index core as part of the overall plan investment menu. Factoring in passive target-date funds, 69% of participants hold equity index investments.

“I do think the fee transparency regulations had a lot to do with this,” Young says. “As plan sponsors look at their investment lineups, they want to be sure they have low-cost passive option for participants.”

NEXT: What the markets did to account balances

Young points to scatter plots in the How America Saves report that show the five-year annualized total return for participants in professionally managed options versus those participants who select investments on their own. The scatter plots show consistent allocations to bonds and stocks and consistently rising returns for those in professionally managed accounts. However, the allocations and returns for those selecting their own investments included many outliers, with some experiencing negative returns.

The How America Saves study found that with essentially flat markets in 2015, the average one-year participant total return was –0.4%. Five-year participant total returns averaged 7.3% per year. Among continuous participants—those with a balance at year-end 2010 and 2015—the median account balance rose by 105% over five years, reflecting both the effect of ongoing contributions and strong market returns during this period. More than 90% of continuous participants saw their account balance rise during the five-year period ended December 31, 2015.

Young explains that the returns participants see depends in part on the size of the account balance. The Vanguard study found the median account balance was $26,000; only 25% have account balances higher than average. Young says there are a few things going on. “The effect of auto enrollment is more small balances. For better or worse, participants don’t get the idea of total return and compounding, so they look at what their account balance is doing. In 2015 when equity was down, ongoing contributions masked that, so while participants might hear about market volatility, what they are experiencing in their own account doesn’t reflect that. Smaller account balances are like rose-colored glasses, and the good thing is it doesn’t make participants panic.”

Young says those with higher account balances may see more of a loss in their accounts, which is not necessarily a bad thing because they are buying low with their contributions.

“The two big criticism for 401(k)s is that participants don’t save enough, and don’t know how to invest. We found the overall contribution rate is 10%, which we’d like to see higher, but it is good. We’ve made much more headway on the participant portfolio construction issue. These are the two things we need to get right,” Young concludes.