Asset AllocationMarch 27, 2014

401(k) and the Passive Investment Revolution

<em>Has the game between active and passive investment already been lost on the 401(k) field?</em>

Reported by Featured Author

(March 27, 2014) — Over the past decade, the investment game has changed for 401(k) plan members, with passive strategies winning the latest round, a survey has found.

Vanguard, a predominantly passive investment manager, published a report this week showing a 51% relative decline in pension scheme members who exclusively used active strategies to manage their 401(k) plans.

“In 2004, 39% of participants were invested exclusively in active funds. By 2012, this all-active group had dropped to 19%,” the report said. “Conversely, in 2004, 10% of participants were invested solely in index funds. By 2012, that figure was 38%, a nearly fourfold increase.”

For those using a blend of the two approaches, Vanguard found passive strategies had won out. In 2004, some 30% of 401(k) assets were invested passively; by 2012, this had increased to 60% of the entire portfolio.

The difference in approaches is starkly displayed when looking at who is doing the investing.

Some older 401(k) plan members remained 100% invested in active strategies, which Vanguard attributed to “inertia”. Younger investors often had 100% passive strategies in their plan, “largely because they were automatically enrolled in plans with index-based target-date funds as the default investment,” Vanguard said.

Employers and plan sponsors have played a significant part in this structural shift, Vanguard added: “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.”

Vanguard also found a shift out of funds that were non-indexable, such as money market funds over the 2004 to 2012 period. These options used to make up 32% of an average portfolio in 2004; by 2012, they made up just 19%.

This month, a study by professors at Yale School of Management and the University of Virginia found 16% of young US investors would be better off opting out of their 401(k) plan and saving for retirement in a retail index fund.