A second strategy is to offer a managed account advisory service. With such a service, each participant's portfolio is constructed according to a disciplined investment methodology. The participant does not make investment choices, but delegates control to the advisor, who makes all portfolio construction and rebalancing decisions.[12]

Sponsors may also want to consider a new planwide strategy known as "reenrollment." Under reenrollment, all participants are transferred to a QDIA, such as the target-date fund strategy, with prior notice and with a right to opt out. Through inertia, it is likely that many participants will remain in the default investment option after reenrollment. This strategy is explained in more detail in a separate report from Vanguard.[13]

Appendix: Target-Date Vs. Risk-Based Funds[14]

How do the risk exposures from target-date funds compare with those from risk-based or static-allocation funds, the funds that target-date options are gradually replacing? Target-date funds appear to have a close alignment between the participant's age and the time horizon of the fund (Figure 12, top panel). By design, younger target-date participants tend overwhelmingly to choose (or are defaulted into) long-dated funds, while older target-date participants tend to choose (or are defaulted into) near-term funds.

Participants in risk-based funds are expected to complete an investor questionnaire that assesses their time horizon, risk tolerance, and other factors. If participants consistently used this questionnaire, the result would be that risk-based investors would shift over time from higher- to lower-risk portfolios. If participants are defaulted into a risk-based fund, it is typically to a single fund, regardless of age, for the entire plan.

Our results suggest that static-allocation participants are not assessing age and risk tolerance systematically (Figure 12, bottom panel). The most aggressive risk-based fund in our analysis, the growth fund (with 80% in equities), is more likely to be held by participants ages 35 to 44, not by younger participants. Younger participants are typically in the moderate growth fund (60% in equities), which may be because of this fund's popularity as a default fund. Overall, in plans using risk-based funds, there appears to be no pronounced age-based variation in equity exposure.

Target-date funds put the age-based pattern of equity exposure in the hands of the fund manager, not the participant. Risk-based funds require participants to take the initiative to alter their equity allocation over time. The results for risk-based funds suggest again that participants tend to procrastinate and be passive decision-makers, and so do not alter risk exposures in a disciplined way as they age.[15] Again, it is important to emphasize that the results for both types of funds reflect voluntary choices made by participants as well as default decisions made by employers.

References

Mitchell, Olivia S., Gary R. Mottola, Stephen P. Utkus, and Takeshi Yamaguchi, 2007. "The Dynamics of Lifecycle Investing in 401(k) Plans." Working Paper 2007-08. Wharton Pension Research Council. Philadelphia, PA. http://www.pensionresearchcouncil.org/publications/ document.php?file=400.

Vanguard, 2005. Life-Cycle Funds Mature: Plan Sponsor and Participant Adoption. Vanguard Center for Retirement Research. Volume 20. Malvern, PA. https://institutional.vanguard.com/VGApp/iip/site/ institutional/researchcommentary/article?File= LifeCycleFundsMature.

Vanguard, 2008a. Evaluating and Implementing Target-Date Portfolios: Four Key Considerations. Vanguard Investment Counseling & Research. https://institutional.vanguard.com/VGApp/iip/site/ institutional/researchcommentary/article?File= EvalImplemTargetDatePortfolios.

Vanguard, 2008b. Improving Plan Diversification through Reenrollment in a QDIA. Vanguard Strategic Retirement Consulting. https://institutional.vanguard.com.

Endnotes

1. Source: Strategic Insight. These figures are a lower bound estimate of assets in target-date strategies, as they exclude target-date money held in nonfund vehicles, such as commingled funds.
2. In total, 67% of the 3.2 million participants had access to target-date strategies in their employer plan as of year-end 2007, and more than 570,000 participants held a position in one or more target-date funds.
3. See Vanguard (2005) for an analysis of static-allocation funds and Mitchell, Mottola, Utkus, and Yamaguchi (2007) for an assessment of the early adoption of life-cycle funds in DC plans. Vanguard (2008a) also describes the criteria for the selection of target-date funds in a DC plan.
4. These funds, sometimes known as lifestyle funds, require the investor to choose from a series of risk-based portfolios, such as low-, medium-, and high-risk, based either on the fund descriptions or a questionnaire that incorporates time, risk, and other variables.
5. Default funds are the designated investment when a participant is automatically enrolled. They are also used when the employer makes a nonelective contribution for all eligible participants, whether or not they are contributing to the plan, or when a participant has chosen to make elective deferrals but has failed to make an investment choice.
6. Our measures of participants' economic resources includes nonretirement financial wealth-the mean value of nonpension and non-IRA wealth held by households in the same ZIP+4 region, provided by the IXI company.
7. Employer and employee contributions, calculated separately, follow the same 45/55 split as total contributions.
8. The regression is a multinomial logistic regression, relating investor type (mixed, pure or non-target-date investor) to a variety of participant and plan variables, using plan clustering to control for heteroskedasticity. Complete regression results are available from the authors.
9. The target-date funds record kept at Vanguard are exclusively passive or index-based.
10. Another possible reason for a mixed target-date strategy is that the participant is using a managed account advisory service that uses a target-date fund and other options in its portfolio construction process. In our sample of mixed adopters, fewer than 3% used a managed account service.
11. The possible explanations for this U-shaped pattern include the prior use of conservative default investment options, which leads to lower equity exposure among younger, defaulted participants, as well as learning over the life cycle, with young investors first choosing familiar or safe investments in their early 20s, and then choosing riskier portfolios as they learn more about investing and equity markets.  
12. A managed account advice service will not necessarily reduce the number of mixed target-date investors if the advisory methodology also uses a target-date option.
13. See Vanguard, 2008b.
14. This analysis is based on contributions made by single-fund investors only (i.e., those who are not combining the target-date or risk-based funds with other fund holdings).
15. Another possible explanation is that participants and plans who wish to maintain a reasonably constant equity exposure over the life cycle choose risk-based rather than target-date funds. This is a plausible theory, but inconsistent with our prior research on early adoption of life-cycle funds, which suggested, using time series data, that introducing target-date funds led to a larger change in equity exposure by age than did static-allocation funds.

Contributors to this report prepared by the Vanguard Center for Retirement Research include Kathy Berardi, Meg Shearer, Vicky Hubert, Anita Smith and Diane LeBold.

1 | 2 | 3 | 4 | 5 |