New data from the Vanguard Center for Retirement Research reveals that the one-year personalized return for 401(k) plan participants was a 3.1% median annualized gain for the year ended June 30, 2003, a marked turnaround from the -13.3% trailing one-year return in December 2002.
Existing participants are continuing to pour new contributions into equity investments, roughly two-thirds of new money, while fixed income investments are attracting 34%. There have been shifts, of course – Vanguard notes that the equity allocation is down by 12% since the peak of the bull market.
However, what is most striking about the contribution trends evidenced in the Vanguard data is what is happening with the contribution decisions of newly eligible participants. During the first six months of 2003 this group allocated just 48% of their contributions to equities, investing the balance in fixed income. This during a period when existing participants in these same programs continued to direct about 70% of their new contributions into stocks.
Vanguard notes that given the size of the samples in the study, there is “no reason to believe that the participants who enrolled near or at the top of the bull market are any different in their risk tolerance than the group who enrolled in the midst of the bear market.” Indeed, Stephen Utkus, author of the report, notes that “It seems the only material difference is that new enrollees had to make an active choice, and so their portfolio decisions were more sensitive to then-current market conditions.”
This result highlights two key participant behavioral traits. The first is participant inertia, the tendency not to make changes in one’s asset allocation mix over any period of time (or, as Newton’s first law suggests, a body at rest will remain at rest unless an outside force acts on it). The second key trait is what Utkus describes as the “anchoring effect” of the initial participation decisions on subsequent decision-making by the participant. The Vanguard study notes that a possible explanation for the continued high commitment to equities (relative to the new participant group) is that existing participants are “making risk judgments not on an absolute basis, but in reference to their initial decision.” In effect, that first decision about participating and investment serves as an “anchor” for subsequent decisions.
The Vanguard study finds that since December 2002 median account balances have grown 14%, and now total more than $17,700 (the median account balance being the "middle" participant, with half of the sampling above and below that level - the "typical" plan participant, according to Vanguard). On the other hand, the average participant balance (which are reflective of longer-tenure, older participant balances), has grown 9% during the past six months, and is now some $49,700. Vanguard notes that since the top of the bull market at the end of 1999, median balances are 13% higher, while average balances are down about 1%.
Vanguard notes that the participant returns have generally fared better than major US stock indices during the bear market due to the proportion of fixed income investments in participant accounts, and the benefits from dollar-cost averaging, which, among other things, kept new cash contributions from being invested in periods such as July 2002, one of the worst months during the bear market.
All in all, Vanguard notes that for participants account balances are more important than investment returns as a metric for plan performance. The benefit of ongoing contributions manifests itself in two ways - both to accentuate the positive returns in a rising market, and as a buffer against declining returns in a down market.
As for transfer activity, the study reveals that during the first six months of 2003, about 8% of Vanguard participants made one or more transfers in their account. That pace (which would amount to 16% on an annualized basis), is higher than the past two years (but only by 1-2%), and slightly below the levels recorded at the top of the bull market. However, that net movement accounts for only six-tenths of 1% of average recordkeeping assets, according to Vanguard.
The Vanguard report is online HERE .
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