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Target-Date Investors Seem to Be Behaving Well

John Croke says spikes in volatility are generating less trading activity than expected among target-date fund investors.

Note: This video is one of several interviews that Morningstar director of personal finance Christine Benz had with Vanguard officials at this year's Bogleheads event. See all of the interviews here.

Christine Benz: Hi, I'm Christine Benz for Has the uptake of target-date retirement funds helped to improve investor outcomes? Joining me to discuss that topic is John Croke. John is the head of multi-asset product management in Vanguard's portfolio review department. In that role, he is responsible for Vanguard's target retirement funds and the overall product strategy. 

John, thank you so much for being here.

John Croke: Thank you. It's good to be here.

Benz: John, Vanguard's Target Retirement series just passed the 15-year mark. Looking at the assets in the target retirement funds right now, what's the rough allocation between company retirement plans like 401(k)s and self-directed IRAs?

Croke: Good question. If you look at the target-date fund market holistically, inclusive of both mutual funds and collective trusts, it's about a $2 trillion market overall. We estimate about 10% to 15% of those investors are actually retail investors, investors owning these products outside of an employer plan. That's a lot of money, $200 billion, $250 billion of assets that are with this cohort of investors who have opted to invest in these products not because it was something they were swept into or the only option in their plan. They've decided that a professionally managed, low-cost single-fund solution is appropriate for them and their needs.

Benz: With the company retirement plan assets, a lot of the assets in the target retirement funds have grown in the wake of the Pension Protection Act, right, which made those default option?

Croke: Yes. That was the big catalyst back in 2006, but there has been another tailwind beyond regulations in the employer-sponsored community in terms of greater adoption of what I'll call best practices around planned design, more and more employers getting comfortable with, when they have new employees instead of asking them to fill out some paperwork and send it to the HR department, they are automatically enrolled, often at about 3% give or take. Without having to take any action, they are already saving for retirement. The overwhelming investments of choice for this defaulted or automatically enrolled participant is a target-date fund of default investments in employer plans, we estimate that somewhere around 96% to 97% of plans choose a target date fund as opposed to a traditional balanced fund or perhaps a managed account to serve this very specific need for their participants.

Benz: I want to talk about balanced funds and static allocation funds that don't change their allocations to become more conservative as the years go by. Is there a role for those products? It seems that target-date funds have probably gained market share at the expense of some of the static allocation funds. How do you see those two co-existing?

Croke: They are very much a role, very much an important tool in the broader tool kit that all investors have at their disposal. We have very large franchise of static allocation balance funds, both index and actively implemented here at Vanguard.

We believe they are critical ingredient for success there is an investor who knows enough of their own risk tolerance, their attitudes toward potential upside relative to downside and make a well-informed decision around what mix of stocks and bonds or risky and diversifying assets are appropriate for them.

But if you are an individual who doesn't have the time, willingness, or ability to contemplate those more nuanced elements of investing or want to entrust a professional to steer you toward a reasonable and balanced strategy that will automatically take less risk as you get older and have less capacity to take risk, target-debt funds serve that role. We think they are complementary for different types of investors at different levels of engagement, and I think they will continue to flourish both independent or each other.

Benz: The thing I want to touch on is the fact that, at Vanguard because these are your funds, you can observe participant behavior in real time. You can see what they are doing. One thing we see as observers of target-date funds at Morningstar is we tend to see that the typical target-date investor does a pretty good job of staying put. Is that corroborated by your look at the data of asset flows and so forth?

Croke: Yes, that's very much the case. That is exactly what we observed through the global financial crisis. If you think about more recent periods, where we haven't had a whole lot.

Benz: We haven't.

Croke: … of turmoil or volatility in the market, there were couple weeks back in the February-March time frame of this year, of 2018, where you saw that spike in volatility. We went back and we were comparing all Vanguard investors; target-date investors versus do-it-yourself investors. The good news is what we saw on the whole was less activity than you would have anticipated given the spike in volatility and the spike in headlines in financial media.

Benz: Across all of those groups.

Croke: Across all those groups, but target debt funds in particular. It's a classic case of taking the bad inertia of in action and making it good inertia by taking that in action and giving it that balanced, professionally manage the asset allocation.

Benz: Once people make their initial choices or maybe get opted in, they tend to stay put, is that what you are finding?

Croke: Exactly. I often point people to the data that Morningstar publishes around investor returns versus fund level returns. Target-date funds as a category stand out as a product where it would appear based on the difference between fund level returns and investor returns, what they actually realize when you adjust for cash flows, target-date fund investors do a good job of sticking with it. You will also see the benefits of dollar cost averaging …

Benz: Continuing to add even when things are down.

Croke: Exactly. It's a good news story in the broader retail investment universe.