Vanguard has partnered with plan sponsors for decades to lower the cost of investing for participants. Last week marked another low-cost milestone as we reported lower expense ratios for 35 investment offerings, including 12 Target Retirement Funds. This is great news for participants and, ultimately, for all investors.
When Vanguard enters new markets or introduces new products, other investment providers take notice and respond with price reductions of their own. “The Vanguard Effect” lowers the cost of investing for everyone, and we’ve seen this play out in the 401(k) world with expenses decreasing across all asset classes in recent years.¹
Average expense ratios of mutual funds in 401(k) plans
Sources: Brightscope and Investment Company Institute, 2015.
However, there’s more to this story than investment providers lowering expense ratios. Plan sponsors have been a driving force in keeping participants’ investment costs in check. A plan can offer an array of low-cost investment options for employees, but will participants make choices that match their goals? Everything we’ve learned from the field of behavioral finance suggests the answer is “no,” so something else has to bridge the gap between options and action. Cue “The Plan Sponsor Effect”—the power of plan sponsors to guide good decision-making with effective plan design and carefully curated investment lineups.
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Let’s start with plan design, which includes automatic enrollment and the use of default investments. Research shows defaults are sticky. In other words, participants tend to stay where their plans put them. A recent Vanguard study found that 7 in 10 new hires remain exclusively invested in their plan’s default fund, which increasingly is a target-date fund (TDF). We believe this trend is great for many investors who benefit from the low costs, diversification, and automatic rebalancing of these all-in-one funds.
Defaults aren’t just helpful for new hires. More plan sponsors are using reenrollment to help tenured employees bring more diversification and less expense to their retirement portfolios. A recent case study showed participants’ average investment fee dropped by 75% after their plan reenrolled them into an indexed TDF.² Over time, these cost savings can compound into real retirement dollars for participants.
Keeping lineups manageable and organized into well-defined tiers is another way plan sponsors can guide participants’ investment decisions. Increasingly, we see plans using a three-tiered lineup—TDFs, followed by a core set of broadly diversified investments, and then any supplemental funds. Needless to say, we recommend a low-cost approach across the board.
At Vanguard, we’re proud to keep costs low for investors, but let’s give credit where credit is due. “The Plan Sponsor Effect” is real and is having a material impact on participants’ expenses, and ultimately, their retirement prospects. The less participants pay for their investments, the more likely they’ll stay on the path to retirement readiness.
¹BrightScope and Investment Company Institute. 2015. The BrightScope/ICI Defined Contribution Plan Profile: A Close Look at 401(k) Plans, 2013. San Diego, CA: BrightScope and Washington, D.C.: Investment Company Institute.
²Pagliaro, Cynthia A. and Stephen P. Utkus, [forthcoming]. Reshaping participant outcomes through reenrollment. Vanguard Center for Retirement Research.
- All investing is subject to risk, including the possible loss of the money you invest.
- Diversification does not ensure a profit or protect against loss.
- Investments in target-date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in target-date funds is not guaranteed at any time, including on or after the target date.