The use of low-cost index funds in Vanguard 401(k) plans doubled from 2004 to 2012.
According to Vanguard’s “Behavioral Effects and Indexing in DC Participant Accounts 2004-2012,” the average participant now invests 60 percent of his account balance in index funds, compared to 30 percent in 2004, in large part because of the growing popularity of index-based target-date funds.
The study also found that the assets in actively managed funds and non-indexable assets, such as money market funds, stable value funds and company stock, declined significantly over the eight-year period, dropping from 32 percent in 2004 to 19 percent in 2012.
The study highlighted a steep drop in the number of participant accounts invested solely in actively managed funds, and found a concurrent increase in all-index accounts. In 2004, 39 percent of participants were invested exclusively in active funds. By 2012, this all-active group had dropped to 19 percent, a relative decline of 51 percent. In 2004, 10 percent of participants were invested solely in index funds. By 2012, that figure was 38 percent, a nearly fourfold increase.
The report also found that older, longer-tenured participants held 100 percent active portfolios, likely as a result of inertia—they simply never changed their investments. This “inertia effect” is common among existing participants, many of whom never alter their initial allocations. Younger, shorter-tenured participants tended to hold 100 percent index portfolios, largely because they were automatically enrolled in plans with index-based target-date funds as the default investment.
The researchers also examined how participants allocated their ongoing contributions. From 2004 through 2012, the percentage of contributions that participants directed to index funds rose from 32 percent to 64 percent, while the percentage directed to active funds declined from 38 percent to 20 percent.
Another factor influencing participants’ transition to indexed investments is their plan’s investment menu, according to the report. In recent years, more index funds — primarily indexed target-date funds — have been added to plans because of the sponsors’ desire to reduce participants’ investment costs and exposure to active fund risk.
The increased prominence of index funds in plan investment lineups has contributed to participants’ increased adoption of these funds.
Vanguard, headquartered in Valley Forge, Pennsylvania, is one of the world’s largest investment management companies. As of Feb. 28, 2014, Vanguard managed nearly $2.53 trillion in U.S. mutual fund assets.