At a time when many investors are wary of the markets, young participants in defined contribution plans have been loading up on stocks. In 2010, participants in their 20s allocated 85 percent of their assets to equities, according to a recent study by Vanguard Group. That is up from 41 percent in 2003. Have young people become bullish on stocks? Hardly. The big shift can be attributed to efforts by employers to promote stock-heavy target-date funds. The target-date funds are helping employees get appropriate asset allocations, says John Ameriks, who heads Vanguards investing counseling and research group.
Ameriks says that most young employees dont spend a lot of time thinking about stock allocations. Preoccupied with careers and personal lives, plan participants have been embracing target funds because they are convenient solutions that are endorsed by employers. In 2010, new plan participants in their 20s put 44 percent of 401(k) assets in target funds and other balanced funds, according to the Investment Company Institute. That is up from 7 percent in 1998. Target-date funds now have $380 billion in assets, up from $71 billion four years ago. Consultant Cerulli estimates that the figure will climb to $1.1 trillion in 2016.
The target-date funds are designed to serve investors who will retire around a certain date, such as 2020 or 2040. Each fund holds a diversified collection of stocks and bonds. As the retirement date approaches, the asset allocation automatically shifts to become more conservative. Funds that serve participants in their 20s can have up to 90 percent of assets in equities. Retirees may have less than 40 percent in stocks.
Before target funds appeared, employees had to reach their own decisions about asset allocations. In many cases, participants made poor choices, putting all their assets in the stock of their employers or holding outsized positions in fixed income. When Enron went bankrupt in 2001, many employees lost all their 401(k) assets because the entire accounts were invested in company stock. To prevent more disasters, plan sponsors began adopting target-date funds and encouraging employees to use them. The Pension Protection Act of 2006 gave target funds another boost by permitting them to be used as default options in automatic enrollment plans. Under an automatic system, contributions go to a target fund unless employees specify otherwise.
Since the pension legislation passed, many sponsors have added automatic enrollment. According to a study by consulting firm Aon Hewitt, 55 percent of 401(k) plans have automatic enrollment, up from 14 percent in 2001. About 80 percent of the automatic plans offer target funds as the default choice.
The target funds have helped to raise the equity allocations of investors of all ages, Vanguard found. For investors aged 36 to 54 that use target funds, about 70 percent of assets are in equities. That is about 10 percentage points more than the figure for participants who dont have access to a target fund. Besides encouraging increased equity allocations, the funds provide automatic rebalancing and broad diversification. With target-date funds, you get exposure to international equities, small caps and other assets that many participants would ignore otherwise, says Alison Borland, vice president of retirement product strategy for Aon Hewitt.
The big equity allocations in defined contribution plans are particularly notable because they come at a time when many young people have been souring on stocks. After suffering through the technology crash and the financial crisis, many young investors have lost faith in equities and begun shifting to fixed income. According to Vanguard, investors who were born from 1970 through 1979 have less than 40 percent of their assets in stocks. In contrast, investors who were born from 1950 through 1959 retain faith in stocks, keeping more than 50 percent of assets in equities. Outside of retirement accounts, fewer young households are holding individual stocks or stock funds, says Sarah Holden, senior director of retirement and investor research for the Investment Company Institute.
Target-date funds have proved effective at promoting stock ownership partly because investors tend to buy and hold them, rarely shifting assets. Even during the financial crisis, shareholders did not abandon their target funds. In contrast, participants who do not use target funds tend to react badly to market changes, Vanguard found. Among new participants who did not hold target funds, about 10 percent had no equities at all before the financial crisis. But by December 2008, 20 percent were avoiding equities entirely. Those participants were probably making a mistake and could be well-served by switching to target-date funds.