In the U.S., target-date funds in workplace retirement plans have grown from $5 billion in 2000 to $734 billion in 2018, with many benefits for plan members.
A new working paper by Olivia Mitchell, a professor at the University of Pennsylvania’s Wharton School, and Stephen Utkus, principal and director of the Vanguard Center for Investor Research, demonstrates that, over a 30-year horizon, adopting a low-cost target-date fund may improve retirement wealth by as much as 50 per cent.
The paper, which draws on data from Vanguard, looks at member adoption and portfolio exposure one year after a target-date fund is added to a plan’s investment menu to demonstrate how the introduction of the funds substantially changes portfolio outcomes.
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“We show that 28.4 per cent of new entrants into voluntary enrolment plans adopted target-date funds in their retirement savings accounts, whereas only 10.2 per cent of existing employees (worker in the plan prior to the funds’ appearance) switched out of existing investments into these funds,” the paper said.
For plans with automatic enrolment, 78.7 per cent of new entrants adopted a target-date fund. And, in these auto-enrolment plans, 21.7 per cent of existing employees’ invest in the funds, double the rate for employees in voluntary choice plans.
The introduction of target-date funds led to a shift away from plan members’ portfolio selections and towards the target-date managers the plan sponsor selects, the paper noted.
In addition to the findings around improved retirement wealth, the paper found that including target-date funds in retirement savings menus raised equity shares, boosted bond exposure, curtailed cash and company stock holdings and reduced idiosyncratic risk.
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Given the potential benefits of TDFs, employers looking to improve target-date fund enrolment can consider re-enrolment.
“Our results also point to the potential effects of providing low-cost, scalable investment advice more broadly,” the paper said. “That is, low-cost lifecycle investment algorithms such as target-date funds or robo-advice services could potentially help reduce portfolio construction deficiencies in other settings such as retain investment accounts or personal pensions, possibly reducing the heterogeneity of returns across households.”
This article originally appeared on Benefits Canada‘s companion site, the Canadian Investment Review.