Past Performance Pulling Participant Allocations: Vanguard

March 29, 2004 ( - Despite those ubiquitous fund disclaimers, past performance - particularly recent past performance - appears to be driving new participant investment decisions, according to new industry data.

The Vanguard Center for Retirement Research reports in its Participant Report Card for December 2003 that, during the second half of 2003, as a result of the continued upswing in stock prices, the percentage of contributions allocated to stocks among new participants rose to 66% – a sharp contrast with the 48% by new participants in the first half of the same year, when the stock markets were still struggling (see Starting Point Anchors Participant Focus: Vanguard ). Study authors Stephen Utkus and Jean Young say that these results “demonstrate the impact of past performance as a heuristic for those making an active choice in a retirement savings plan – namely new enrollees.” (A heuristic is a rule of thumb or shortcut devised to simplify decisionmaking.)

Bull “Shift”

Vanguard notes that the trend was also in evidence during the recent bull market. For example, participants who enrolled in 1999 and 2000 are currently (still) contributing about 72% to equities and just 28% to fixed income. Participants that previously enrolled are more likely to be subject to inertia in the allocation of their retirement plan accounts.

Vanguard cites several possible explanations for the reliance on past performance, including:

  • Availability – Past-performance data is pervasive, so participants use it simply because it is available.
  • Representativeness – Individuals tend to rely on small sequences of information and extrapolate a lesson that may not be warranted by a longer-term view of the data, such as market returns.

Whatever their subconscious rationale, Vanguard notes that “…faced with pervasive past-performance information as well as the complexity of the investment decisions within their savings plans, many participants seek to simplify the decisionmaking process and rely, in part, on a simple heuristic such as past performance.”

However ill-motivated or unreasoned, those participant behaviors appear to have paid off in 2003. Vanguard notes that during 2003, median defined contribution balances for plans the firm recordkeeps grew 37%, though that only resulted in a $21,000 median account balance. The median is the balance of the middle participant, where half the universe has balances above and half below that result. Vanguard notes that over four years, the typical participant's account balance is now up 35%, as measured by the median.

Average account balances, which Vanguard suggests is not characteristic of the typical participant (but is typical of a participant in the top 30%, based on account balance), rose 28% in 2003 to $58,199. Average balances are more indicative of the experience of long-tenure, affluent, and/or older participants, according to Vanguard.

Track "Mete"

Those results may well be restoring participant confidence in those savings programs. Not surprisingly, Vanguard notes that participants in focus groups mention that account balances are the figure most often used to track their accounts' performance. Indeed, account balances "frame participants' perceptions of risk and return in their retirement portfolios," according to the study. Having said that, Vanguard notes that "account balances are a deceptive measure of investment results," going on to note that ongoing contributions tend to pump up the apparent result in rising markets, and buffer the impact of losses in falling markets.

Regardless of their confidence in these accounts, trading activity in 2003 was relatively subdued by historic standards among Vanguard's database. While money flows were "marginally net to equities for the first time since 2000," Vanguard notes that nearly as many participants chose to move away from stocks as toward the asset class. Moreover, just 14% of Vanguard participants made one or more trades in their retirement accounts last year, consistent with that of the past two years, but less than the 17% and 18% seen at the top of the bull market.

Overall, Vanguard notes that the 14% of participants that transferred last year moved about 16% of Vanguard recordkeeping assets, "significantly below the high churn year of 2000," when roughly 18% of Vanguard participants reallocated nearly a third of average recordkeeping assets (32.6%, some $38 billion). In 2003 overall, participants who shifted funds favored fixed-income investments by a narrow percentage, the first time since 2000. In 2002, Vanguard's data shows 15% of participants reallocated nearly 19% of the average recordkeeping assets at the firm.

The Vanguard recordkeeping statistics are drawn from a database of more than 2.3 million defined contribution participants, representing more than 1,500 sponsoring employers and 2,100 qualified plans.