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Target-date funds led to 75% decrease in ‘extreme’ equity allocations: Vanguard

·Senior Writer

The coronavirus crisis saw extreme whipsawing in the market with the fear and chaotic climate of the spring of 2020 providing a challenge to long-term investors, daring them to stay the course.

But according to this year's edition of "How America Saves," Vanguard's insights show that many of the new retirement saving measures helped ward off rash – and potentially expensive – decisions.

Vanguard said that over the last 15 years the increased adoption of target-date funds has led to a 75% decrease in “extreme equity allocations” in target-date funds.

That’s because these funds, which provide a diversified mix of stocks and bonds that automatically rebalances over time, are meant to be left alone until they reach their so-called target date. According to Vanguard, 96% of participants who had a target-date fund in their retirement account didn't make a single trade in 2020 in those accounts.

Many employer 401(k) plans now default employees into target date funds. Interestingly, this move has coincided with a phasing out of investing in company stock through 401(k)s, which was not uncommon for many years. In the past decade, the percentage of people who invested at least 20% of their account in company stock (where it was available) fell from 30% to just 12%, according to Vanguard. Many companies don’t even offer a stock option anymore, electing for funds only.

Besides having a 401(k) default into a target date fund, an even bigger key tool that’s seen widespread adoption across companies is a default contribution (again, usually into a target-date). Vanguard says automated enrollments result in employees saving 50% more per pay period. More than half – 57% – of Vanguard's plans default workers into contributing 4% of their paychecks to a 401(k). (The average deferral is about 7%.)

The third change in defaults/automation is annual automatic increases in contribution amounts. These have resulted in balances 20%-30% greater after three years compared to those at companies without defaults in place. Around two-thirds of Vanguard’s plans with auto enrollments have these increases.

Although workers automatically enrolled can opt out of the 401(k) plan at any time, few choose to do so. According to a classic research paper on default 401(k) enrollment, participation rates at all three companies that were studied exceeded 85%, regardless of how long the employee worked there. Before automatic enrollment began, 401(k) participation rates ranged from 26%-43% after six months of tenure at the three firms and 57%-69% after three years.

Vanguard has 4.7 million people with “defined contribution plans” like 401(k)s, but the U.S. now has over 100 million people using plans like these, with many of these similar behavioral tools that Vanguard offers. However, it is the companies that decide how to structure their own plans, so much of these decisions come down to employers, given the fact that employees often don’t bother to do much with their accounts. With these takeaways, it’s likely the trends could shift even further to support automation and defaults.

Ethan Wolff-Mann is a writer at Yahoo Finance focusing on consumer issues, personal finance, retail, airlines, and more. Follow him on Twitter @ewolffmann.

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