COVID-19 spurred rise of self-directed investors
Some DC plan participants opted for self-direction in 2020, but at what cost?
Amid the uncertainty of 2020, more retirement plan participants opted to begin making investment decisions on their own, according to a report by Morningstar. About 3.5% of target-date fund users and 3% of managed account users switch to a self-directed strategy, according to the report.
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The paper is based on allocation decisions for over 520,550 retirement plan participants. Written by David Blanchett, head of retirement research; Tony Perrin, senior vice president of business development; and Diana Velasquez, senior vice president of consultant relations, the paper shows that plan sponsors may need to consider re-enrollment strategies to nudge participants back into professionally managed accounts, and avoid further losses that come from emotional investment decisions.
Participants who opted for self-direction tended to be men with higher incomes and higher balances. Altogether, 41% of retirement plan participants are self-directed.
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Allocation changes
About 13% of this segment made equity allocation changes that were greater than 5%. They tended to be older, with higher incomes and balances, and favored more conservative investments — their portfolio changes solidified this preference, as participants reduced their equity allocations by an average 17 percentage points in the first quarter of 2020.
After the initial market volatility settled, equity allocation changes slowed, but still continued with declines of 2.4 and 1.4 percentage points in the second and third quarter.
By the end of 2020, participants were slowly getting back into equities, with average allocations increasing by 0.1 percentage points.
Younger investors with conservative investments were much more likely to increase their allocation to riskier investments, Morningstar found, while those who were starting with a riskier portfolio made only minor reductions in those allocations.
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“These results strongly suggest age is an important driver of how investors respond to market turmoil,” according to the authors. It might be tempting to think that more experience would make older investors better at it, they were the ones most likely to make more extreme changes in their portfolios, they wrote.
“This suggests older participants are likely to benefit the most from being invested in a professionally managed solution (for example, target-date funds or managed accounts) since these types of investments proved to be significantly stickier during the first quarter. Unfortunately, older investors appear to be relatively less interested in delegating investment-management responsibilities,” they continued.
Participants who made allocation changes likely lost money on their decision, Morningstar found. The authors estimate that a participant who started with a 75% equity allocation, who rebalanced to 54% by the end of 2020, would have earned 7.5% on a $100 investment.
New participants
Retirement plan participants who enrolled in a plan last year were less likely to choose a professionally managed portfolio if they enrolled in April than in almost any other month, Morningstar found.
Older participants joining a new plan were especially unlikely to enroll in a professionally managed portfolio, but the preference for self-direction held across all age groups except the under-30 participants. Another notable drop occurred in November, with the same age distribution.
“This research strongly suggests that there is an additional value associated with professionally managed investment solutions for 401(k) participants, because participants using these options were less likely to make changes during the period of recent market volatility,” the authors concluded.
“Participants need help, and it is essential that plan sponsors make professionally managed investment solutions, such as target-date funds and retirement managed accounts, available to keep participants on the road to a successful retirement.”
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