By now it’s generally accepted that 401k and similar defined contribution plan defaults are good, since they get people invested—and bad, since they sometimes “trap” participants at a low rate.
Past research suggests that demographics can significantly influence a plan participant’s choice to simply accept the default investment.
Now, new research from Morningstar notes that “target-date funds have risen above other options to become the predominant default investment choice for employers.
However, it adds, “there has been little research exploring the stickiness, or the likelihood of participants accepting and continuing to use the default. Differences in acceptance and usage could mean that employers may need to reconsider how they select their plan’s default investment.”
Three important points
The paper, titled “Which Default Investment Is the Stickiest?”, from David Blanchett, head of retirement research at Morningstar Investment Management, and Dan Bruns, Vice President of Product Strategy at Morningstar Investment Management, explores four key attributes associated with a plan’s default investment, such as expense ratio and relative performance, and finds that:
- While certain TDF attributes do have a relation to default investment acceptance, the fund’s attributes tend to be less important than certain participant demographic variables, such as income and balance.
- Default investment acceptance increases for TDFs with lower expense ratios, lower levels of equity risk, and higher relative performance, with expense ratio having the largest effect among the three.
- By understanding the drivers associated with acceptance of a default investment, plan sponsors and DC plan consultants might have additional success getting more participants into professionally managed investment options with the ability to predict which default investment will be most accepted.
“While far from perfect, target-date funds are professionally managed multi-asset portfolios that are likely to result in better investment outcomes than if a participant was to self-direct his or her own portfolio,” Blanchett and Bruns write. “Therefore, the goal should be to get as many participants in the default investment as possible, and to keep them there.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
