Introduction

The use of target-date funds has grown rapidly as a retirement investing strategy over the past decade. In a target-date fund, an investor receives a portfolio based solely on an expected year of retirement. All portfolio allocation decisions are delegated to the fund manager. Assets in target-date funds expanded from $2 billion in 1997 to $183 billion in 2007—a compound growth rate of more than 50% per year. The number of investment firms offering such funds grew from 4 to 37 over the same period.[1]

Target-date funds have radically simplified portfolio management decisions for retirement investors. The funds provide wide diversification among a large range of asset classes in a single investment option. They also gradually reduce equity exposure as the investor approaches the target retirement date of the fund—the so-called "equity glide path." As such, target-date funds are thought to be particularly valuable for less sophisticated investors who struggle with the task of portfolio construction. They are also appealing for investors who don't wish to reassess portfolio risk levels as they grow older.

Driving the growth rate of target-date funds has been their increased use in defined contribution (DC) retirement plans. Their use in DC plans is likely to expand given their designation by the U.S. Department of Labor as one of three qualified default investment alternatives (QDIAs)—along with balanced funds and managed accounts—under the Pension Protection Act of 2006.

In this report, we assess the impact of target-date funds on DC plans using recordkeeping data drawn from more than 2,200 DC plans and nearly 3.2 million participant accounts record kept by Vanguard. Within this universe, more than 1,300 plans, or nearly 60% of the total, offered target-date funds as of year-end 2007, and more than 350,000 participants were actively contributing to the strategy.[2] This analysis builds upon our earlier work on life-cycle funds—both our initial study of static-allocation or risk-based funds, as well as our more recent work on the early introduction of life-cycle funds in DC plans, jointly authored with researchers at the Wharton School of the University of Pennsylvania.[3]

We begin by examining plan and participant adoption. We then turn to the two types of target-date investors—pure and mixed investors—and their characteristics. We also discuss the impact of target-date holdings on the age-based pattern of equity exposure, and in an appendix, compare target-date and static-allocation funds.

Plan Adoption

As of year-end 2007, nearly six in ten DC plans using Vanguard recordkeeping services offered participants a series of target-date funds (Figure 1). Over the past five years, there has been a gradual substitution of target-date funds for static-allocation or risk-based life-cycle funds.[4] A little more than half of Vanguard-administered plans offered risk-based funds in 2004, and that level has now declined to 37%.

Among the important drivers of target-date fund adoption has been the growing use of automatic enrollment, as well as their increased designation as QDIAs.[5]  Of the Vanguard DC plans allowing employee-elective deferrals, 15% have adopted automatic enrollment, principally for new hires. Of that 15%, more than 80% have designated a target-date fund as the default investment (Figure 2).

As of December 2007, 27% of all Vanguard DC plans had designated a QDIA, and more than 80% of these plans employed a target-date option. By September 2008, the number of plans adopting a QDIA had risen to 40%, and again, more than 80% of these plans used a target-date fund as the default investment.

By comparison, money market and stable value funds remained the dominant default fund strategies among those plans that had not introduced automatic enrollment nor designated a QDIA as of year-end 2007. These types of default options are expected to decline as sponsors continue to designate QDIAs for their plans.

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