Morningstar Investment Management published a new research paper, “The Impact of the Default Investment Decision on Participant Deferral Rates: Managed Accounts vs. Target-Date Funds,” which is sure to stoke some serious debate among the investment industry.
Key data points cited in the research paper suggest those investors who were previously defaulted into managed accounts tend to save around 1% more on average compared with those defaulted into a target-date fund (TDF). The data comes from 66,000 actual participants enrolled in 195 defined contribution plans that offer either a target-date fund or managed accounts as the plan default investment.
Important to note, the difference in deferral rates declines to approximately 0.5% after controlling for plan and participant attributes, such as industry or tenure, but Morningstar stresses this is still a significant contribution gap that can have a big impact on wealth by the end of a 30- or 40-year investment cycle. In fact, Morningstar argues the increased savings benefits measure among managed account users are likely to outweigh the costs of such products over TDF pricing, especially for those with smaller account balances relative to their incomes.
“The average participant, who is assumed to be 45 years old and does not roll over a balance upon enrollment, would benefit from using a managed account if the annual fee were 2.4% of total assets or lower—as long as savings rates increase, not taking any other potential benefits of managed accounts into consideration,” the report claims.
Other findings suggest outperformance of managed account investors compared with TDF investors at the median is even stronger, with those DC participants defaulted into a managed account saving 2% of salary more than the median participant defaulted into a TDF, at 6% and 4%, respectively.
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“At the median plan level, defaulted managed accounts participants saved 1% of salary more than those defaulted in target-date funds, at 6% and 5%, respectively,” Morningstar clarifies. Much, but not all, of the difference can be explained by different attributes of participants in plans that utilize managed accounts as the default (vs. TDFs).
For example, plans with managed accounts as the default tend to have older participants with higher levels of plan tenure and higher salaries, and each of these attributes are associated with higher savings levels. However, after controlling for these variables and other important plan characteristics, individuals defaulted into managed accounts still tend to save more for retirement at the average and the median, “although the level differs by model (i.e., regression) ranging from 0.3% to 1.9%.”
Other data shows participant deferral rates are generally lower for plans with automatic enrollment, versus voluntary enrollment, unless the default deferral rate is at least 6%.
“A plan with a 3% default enrollment rate will have deferral rates that are approximately 1.6 percentage points lower than if the plan offered voluntary enrollment,” Morningstar observes.
The research concludes that managed accounts and TDFs alike are important parts of the investment product continuum, but “managed accounts participants exhibit a much wider dispersion of equity allocations, especially near retirement, showing the greater customization capability of managed accounts.”
The full analysis is available for download here.
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