401(k) and the Passive Investment Revolution

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

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.