DC Plan Participant Use of TDFs Continues to Grow

While target-date funds (TDFs) are intended to automatically diversify retirement plan participants’ portfolios, Vanguard found nearly one-third mix TDFs with other investments and “are pursuing what appear to be reasonable diversification strategies.”

In 2018, 59% of Vanguard participants were invested in a “professionally managed allocation”—their entire account balances were invested in a single target-date fund (TDF), a single target-risk or traditional balanced fund, or a managed account advisory service.

Driving this development is the growing use of TDFs, Vanguard says. Among its DC business, 52% of participants were invested in a single TDF in 2018—a percentage that has more than tripled over the past decade. Among new plan entrants (those entering the plan for the first time), 84% of participants were invested in a single TDF. Vanguard anticipates that eight in 10 participants will be invested in a professionally managed option by 2023.

TDF adoption by Vanguard plan sponsor clients grew from 75% of plans in 2009 to 93% of plans in 2018. TDFs accounted for more than one-third of total Vanguard DC plan assets and more than half of total DC plan contributions in 2018.

According to Vanguard, automatic enrollment—and the choice of the TDF series as a default investment—is a major factor in the rise of TDFs. However, whether or not they use automatic enrollment, 90% of all Vanguard plans had selected a TDF or balanced fund as a default investment by year-end. Eighty-four percent of plans had specifically designated a QDIA, and among those, 97% of the QDIAs were TDFs and 3% were balanced funds. Ninety-eight percent of plans with automatic enrollment are using TDFs as their default fund.

By year-end 2018, nearly all Vanguard participants (97%) were in plans offering TDFs, and eight in 10 participants whose plans offered TDFs had an investment in them. Among participants investing in TDFs, 58% of account balances on average were invested in these funds. Participants holding TDFs directed 81% of their 2018 total contributions to TDFs.

Vanguard found that “pure TDF investors,” or those who hold only a single TDF, accounted for 68% of all TDF investors in 2018. Of this total, about half joined their plan under automatic enrollment, where they typically were enrolled in a single fund by default; and about half joined their plan through voluntary enrollment, where they typically actively chose a single TDF. Vanguard research shows that pure TDF investors are more likely to be younger, lower-wage, shorter-tenured participants with lower 401(k) account balances than other investors. Sixty-three percent of single-TDF investors were younger than 45.

The remaining target-date investors are “mixed investors”—investing in a TDF in combination with other investments (or, rarely, hold multiple TDFs). In 2018, 32% of all TDF investors were mixed investors. Vanguard research indicates that about half of mixed investors arise because of plan sponsor action, including employer contributions in company stock, non-elective contributions to the plan’s default fund, recordkeeping corrections applied to the plan’s default fund, or mapping of assets from an existing investment option to a TDF default because of a plan menu change.

The remaining mixed investors intentionally construct a portfolio of both target-date and non-target-date strategies. Vanguard survey results show that most TDF investors understand the basic risk and return features of TDFs. Large percentages of participants report that they held other assets to make their portfolio allocation more conservative, more aggressive, or more customized. Forty percent cited diversification as a reason for holding additional investments along with a TDF.

Vanguard says one of the benefits of increased TDF adoption by DC plan sponsors and participants is that they eliminate extreme equity allocations. “Do-it-yourself” participants tend to hold greater extremes in equity exposure, and according to Vanguard, about two in 10 do-it-yourself investors hold extreme portfolios (no equities or only equities).

More information from Vanguard’s analysis may be found at https://institutional.vanguard.com/iam/pdf/TDFADOPT_2018.pdf.