Use of low-cost index funds in 401(k) plans doubled from 2004 to 2012, according to a new study from Vanguard, which says the finding highlights the critical role plan sponsors play in participants' investment strategies.
“The movement to index investing is good news for participants who are obtaining broadly diversified exposure to the market at a low cost, which can ultimately help them accumulate more money for their retirement,” Cynthia Pagliaro, lead author of the study and an analyst in Vanguard’s Center for Retirement Research, said in a news release.
Vanguard said participant investment allocation changes in its 401(k) plans were as follows:
The percentage of participants invested solely in index funds rose from 10 percent in 2004 to 38 percent in 2012. The study also found that older, longer-tenured participants held 100 percent active portfolios, likely as a result of inertia. Younger, shorter-tenured participants tended to hold 100 percent index portfolios, largely because they were automatically enrolled in plans with index-based target-date funds as the default investment.
Another factor influencing participants’ transition to indexed investments is their plan’s investment menu, according to the report. In recent years, more index funds — primarily indexed target-date funds — have been added to plans because of the sponsors’ desire to reduce participants’ investment costs and exposure to active fund risk. The increased prominence of index funds in plan investment lineups has contributed to participants’ increased adoption of these funds.
In addition, for participants who want to voluntarily choose their investments, target-date funds can offer a simplified choice, because they can be chosen based on the investors’ expected retirement age.
“The results of this report highlight the critical role that plan sponsors play in the investment strategy of participants,” Pagliaro said. “Due to these behavioral effects, it is likely that the sponsor’s decision will have a profound influence on the investment choices made by their participants.”
Vanguard, headquartered in Valley Forge, is one of the world’s largest investment management companies, with nearly $2.53 trillion in U.S. mutual fund assets. It offers more than 160 index and actively managed funds to U.S. investors and more than 100 additional funds in non-U.S. markets, and provides investments to nearly 4,000 defined contribution plans, including full-service recordkeeping and investment services to about 3.5 million participants.