The use of low-cost index funds by participants in Vanguard 401(k) plans rose sharply from 2004 to 2012, with the average participant now investing 60% of his or her account balance in index funds, according to a Vanguard study.
The researchers noted that this percentage has doubled since 2004, largely as a result of the growing popularity of index-based target-date funds.
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The study, Behavioral Effects and Indexing in DC Participant Accounts 2004-2012, also found that the assets in actively managed funds and non-indexable assets, such as money market funds, stable value funds, and company stock, declined significantly over the eight-year period. The following table summarizes the paper’s findings:
Cynthia Pagliaro, lead author of the report and an analyst in Vanguard’s Center for Retirement Research, said: "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."
The study highlighted a steep drop in the number of participant accounts invested solely in actively managed funds, and found a concurrent increase in all-index accounts. In 2004, 39% of participants were invested exclusively in active funds.
By 2012, this all-active group had dropped to 19%, a relative decline of 51%. Conversely, in 2004, 10% of participants were invested solely in index funds. By 2012, that figure was 38%, a nearly fourfold increase.
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By GlobalDataThe report also found that older, longer-tenured participants held 100% active portfolios, likely as a result of inertia — they simply never changed their investments. This "inertia effect" is common among existing participants, many of whom never alter their initial allocations.
Younger, shorter-tenured participants tended to hold 100% index portfolios, largely because they were automatically enrolled in plans with index-based target-date funds as the default investment.
The researchers also examined how participants allocated their ongoing contributions, which are a better indicator of their future investing intentions than the current composition of their accounts. From 2004 through 2012, the percentage of contributions that participants directed to index funds rose from 32% to 64%, while the percentage directed to active funds declined from 38% to 20%.
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.
Pagliaro said: "The results of this report highlight the critical role that plan sponsors play in the investment strategy of participants. 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."
