DC participants move away from extreme investment choices

Defined contribution plan participants have become less extreme in their investment strategies, moving away from lopsided allocations of equities or fixed income to a more diversified investment lineup.

Although participants are acting in part on their own accord, record keepers that track clients' investing behavior say plan design changes over the years are the driving force.

At Fidelity Investments, Boston, extreme portfolios — either 100% equity or zero equity — have declined dramatically since 2006, the year the Pension Protection Act was enacted. Among other things, the law established qualified default investment alternatives, which have spurred the growth of target-date funds. Balanced funds and managed accounts are the other QDIAs endorsed by the law. The PPA also encouraged greater use of auto enrollment by providing a safe harbor for sponsors.

"Since the PPA, a lot of sponsors have really changed their plan designs," said Katie Taylor, Fidelity's vice president of thought leadership. Increased implementation of auto enrollment and auto escalation also have led to fewer extremes and greater diversification in participants' account balances, she said.

By year-end 2006, Fidelity said 34.7% of participants among its record-keeping clients had extreme portfolios. Since then, the rate has dropped every year, falling to 10.5% in 2018. For the first quarter of 2019, the extreme portfolio rate was 10%.

Among its clients, Fidelity said 8% of plans used a target-date series as a QDIA in 2006; by the first quarter of 2019, the rate had jumped to 90%.

Also, 6% of participants invested all of their retirement money in target-date funds in 2006. By the first quarter of 2019, the rate was up to 52%, based on Fidelity's analysis of 22,800 corporate DC plans — including adviser-sold DC plans — covering 16.8 million participants as of March 31.

When it analyzed six age categories, Fidelity found that extreme portfolio allocations steadily increased with age — from 5.2% of those in the 20-29 group to 25.2% in the 70-plus category. Older workers are less likely to be in target-date funds and more likely to be self-directed investors, Ms. Taylor said.

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Alight Solutions, Lincolnshire, Ill., has found that DC plan participants have maintained essentially stable rates for 100% equity allocations in recent years, but the rates for participants with zero equities has declined.

"Equities have been outperforming, so maybe they are chasing winners," said Robert Austin, the Charlotte, N.C.-based director of research. He suggested that some participants might be emboldened to allocate more to equities if they also are covered by a defined benefit plan.

From Jan. 1, 2014, to Jan. 1, 2019, the annual rate of 100% equity allocations for active participants drifted slowly to 4.8% from 5.1%. During the same period, the rate of participants with zero equity allocations dropped steadily to 2.7% from 5.4%.

When Alight examined allocations by demographics, it found that the percentage of participants holding zero equities increased with age — 0.5% for workers under 20 to 5.6% for those 60 and older, according to Jan. 1, 2019, data that measured six age categories.

It also found that the percentage of participants going all in on equities rose steadily in five of six age categories — starting at 2% among people younger than 20, rising to 5.6% in the 50-59 group. The 60-plus group's 100% equity rate was 4.8%.

Some older participants "are more engaged" in their investing, Mr. Austin suggested. "There will always be extremes."

Alight data also show that higher all-equity allocations are reflected in the size of participants' accounts. Those with higher balances had higher percentages of 100% equity allocations. Tracking 11 account balance categories from less than $10,000 to $100,000 or more, Alight found that the largest balance categories — those individuals with balances of $70,000 or more — had extreme equity portfolio rates ranging from 7.3% to 8.4%

Alight's latest research covers 121 DC plans, most of which are clients, with $378 billion in assets, covering more than 3 million participants.

Vanguard Group Inc., Malvern, Pa., also found that participants in its record-keeping plans retreated from holding extreme portfolios with the passage of the Pension Protection Act thanks to "professionally managed allocations," which Vanguard defines as target-date funds, managed accounts or balanced funds.

The percentage of participants investing solely in equities dropped to 6% last year vs. 19% in 2006. The percentage of participants holding no equities fell to 3% from 13% during the same period, according to Vanguard's annual report, How America Saves 2019. The report said Vanguard had more than $1.4 trillion in DC assets under management as of March 31, 2019. It is the record keeper for plans with more than 5 million participants.

Before the growth of target-date funds, "young people always skewed risk averse," said Jean Young, senior research associate with the Vanguard Center for Investor Research and the lead author of "How America Saves." "They were allocating like 60-year-olds."

In 2004, for example, Vanguard detected a "humped-shape" allocation trend line "with younger participants adopting more conservative allocations," the report said. Middle-aged participants had the highest equity exposure, "and older participants having equity exposure on par with younger participants," the report said.

By 2018, the equity allocation trend line was "downward sloping by age," according to the report, which noted this reflected the growing use of target-date funds and managed accounts.

One encouraging sign about investors' behavior is that many participants are choosing target-date funds on their own, Ms. Young said.

Among all target-date investors last year, 31% voluntarily invested all of their retirement money in a target-date series. Also, 18% voluntarily enrolled in target-date funds and other investments.

Another subject of extreme investing tracked by Vanguard is company stock. Vanguard noted that Department of Labor says for retirement accounts any single investment in a company or industry exceeding 20% indicates a lack of proper diversification.

Among plans offering company stock, the Vanguard report said the percentage of participants avoiding company stock was 64% last year, up from 45% in 2009. Participants holding 20% or less in their accounts was 17% last year, down from 25% in 2009.

Still, some participants still hold giant amounts, including 5% owning more than 80% of company stock in their accounts. The Vanguard report said large holdings may be due to participants believing that company stock is a safer investment and to employers issuing stock as a company match.

Last year, plans offering company stock as an investment option but making employer contributions in cash had an average of 11% of assets invested in company stock, the report said. Plans offering company stock as an investment option and making employer contributions in stock had an average of 23% of assets in company stock.

Still, the overall approach to reducing company stock's impact "is really improving," Ms. Young said. The reasons: Employers are restricting how much company stock a participant can own, removing company stock as a corporate match and reminding participants of the DOL's 20% recommendation.