It appears American investors are keen for target date funds (TDFs). According to Vanguard’s Target-Date Fund Adoption in 2011 report, nearly one in four 401(k) plan participants invest solely in TDFs—marking a six-fold increase over the past five years.
New plan participants are particularly interested in TDFs: 64% of employees entering their plans for the first time are investing in TDFs.
Vanguard reports that 82% of its DC plans offered a TDF last year. Moreover, among all DC plans at Vanguard, 47% of participants had a position in TDFs, with 24% of all participants invested in a single TDF. The funds accounted for 27% of total plan contributions.
One of the major factors influencing the rise of TDFs is the use of automatic enrollment and plan sponsors’ choosing TDFs as the default investment option. However, Vanguard says that about half of participants investing in TDFs make that decision voluntarily.
“We view this trend as extremely positive because TDFs are providing an increasing number of participants who are neither engaged nor sophisticated investors with balanced, well-diversified portfolios, as well as reducing the risks associated with extreme equity allocations,” said Jean Young, the study’s author and an analyst in Vanguard’s Center for Retirement Research.
In 2011, 18% of Vanguard participants held extreme allocations—10% with only equities and 8% with no equities. In contrast, when TDFs first became available in Vanguard plans in 2004, 35% of participants held extreme allocations—22% invested only in equities and 13% did not invest at all in equities. Target date investors cannot hold extreme positions because target date options include both equity and fixed income asset classes.
The rapid growth of TDF adoption has also led to increased use of professionally managed account options, in which a fund manager or third-party advisor makes portfolio allocation and rebalancing decisions on behalf of participants.
In 2011, the entire account balances of one-third of all Vanguard participants were invested in a professionally managed option—either a single TDF, a single traditional balanced fund or a managed account advisory service.
“In five years, Vanguard estimates that 55% of all participants and 80% of new participants will be invested in a professionally managed option,” said Young.