In a new study by the Center for Retirement Research, “Do Traders Win? Trading Behavior and 401(k) Portfolio Performance,” researchers Gary Mottola and Stephen Utkus report that plan features such as lifecycle or balanced funds, managed accounts or automatic rebalancing services generally lead to higher risk-adjusted returns.
Generally, traders realized higher returns than nontraders but also assumed higher levels of risk, the study said. Before adjusting for risk, traders outperformed nontraders by 0.55% on an annualized basis. After adjusting for risk, however, the difference in returns between the two groups disappeared.
Computing the risk-adjusted returns for 401(k) trading produced “several striking conclusions,” according to Mottola and Utkus:
- The returns of active traders are not statistically different than the returns of other nontraders.
- Passive rebalancers earned the highest risk-adjusted returns – a full 84 basis points per year more than other nontraders. “The gains with passive rebalancing are substantial,” wrote the researchers.
According to the study, “passive rebalancers,” who hold only balanced or lifecycle funds, realized excess annual returns of 84 basis points compared with nontraders on a risk-adjusted basis. Meanwhile, “active rebalancers,” who move their 401(k) portfolio’s equity allocation back to a given target on their own, pulled in 26 basis points worth of higher risk-adjusted returns.
Active rebalancers outperformed other nontraders by more than 2% per year, while passive rebalancers underperformed other nontraders by more than 1.5% per year, the study said.
Mottola and Utkus emphasized that while some level of trading can enhance returns, going too far and suffering high portfolio turnover is not. Traders with the highest turnover rates lost 72 basis points per year compared with traders with the lowest turnover ratios, the study found.
The researchers said plan sponsors can help participants achieve the benefits of portfolio rebalancing in several ways:
- Encouraging the use of investments that offer automatic rebalancing, either by default or through participant education. These include balanced funds, lifecycle funds, or a managed account service.
- Offering a service that provides automatic rebalancing, regardless of the fund holdings selected by the participant.
- Revising the default for rebalancing in defined contribution plans. Wrote the researchers: "…the case could be made that all participant accounts should be rebalanced to their original contribution allocations, unless participants otherwise opt out."
The researchers said Web registered participants with online access to their accounts were less likely to be active rebalancers, and more likely to be active traders. Finally, traders who invested in index funds were more likely to be active rebalancers, "perhaps because they are attracted to the buy-and-hold approach," the report said.
The study was based on a database of administrative records on more than one million active 401(k) plan participants in nearly 1,500 retirement plans.
The study report is here .
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