Vanguard's John Ameriks says most investors should consider their financial situation holistically and tweak a core target date fund with satellite holdings.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com.
Do target-date investors behave any differently from other types of retirement plan investors?
Here to discuss that question is John Ameriks. He is Head of Investment Counseling and Research at Vanguard. John, thanks for being here, today.
John Ameriks: Glad to be here, Christine. Thank you.
Benz: So, one question, I'd like you to address for us, John, is, because participants in target-date plans don't see all these individual investments moving around every day or every quarter, do they tend to behave a little more rationally when managing their assets than people who are trying to control a lot of different investments?
Ameriks: Well, I'm with the rest of the world in not knowing to what degree people are rational or irrational. What I can tell you is that the work that we have done looking at behavior suggests that folks who own target-date funds were a little less likely to engage in transactional activity over the rough patch that we had in the market over the last couple of years.
Now, we don't know whether that's something special to target-date funds or something about balanced fund investors. Basically, they understand, they've got a strategic asset allocation, and they need to stick with it over the long term to let it work. So, I unfortunately can't answer the big question.
Is that a rational choice or is that irrational inertia? It's really difficult to tell that. But we do know that the net result so far has been behavior that we think is consistent with getting to the right place over the long term. So, it's good news on that end.
Benz: Okay. So, in terms of how people put together portfolios that include a target-date fund. You sometimes hear these horror stories about someone picking 2020 and 2030. What do you see in terms of how people put together portfolios that include target-date?
Ameriks: Right. These are the stories of the target-date fund abusers that we hear about.
There are a lot of different patterns in terms of how people use target-date funds, so a couple of things from the work that we've done on this. One is that, in many cases mix portfolios, a target-date fund with something else, doesn't reflect an active choice that was made by an individual, but it may reflect something that a sponsor has done in the context of a plan. And that could be having a match that's in company stock or having closed a fund option and re-enroll people in that fund into a target-date fund and leaving them with that exposure.
So, in a lot of cases, it's not individuals making those changes; it's employers. And employers offer company stock for what they believe to be very good reasons. So, including it as part of a portfolio, we think, can make sense.
We also think that even those individuals who do take steps to hold something other than a target-date fund can do that in a way that's consistent with making best use of their 401(k) plan. We offer 401(k) plans to people to allow them to exercise choice around what types of investments they want to make.
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With a target-date fund and in particular a target-date fund that's index based and relatively passive, so you know what exposures you've got in that fund and how they're going to change, then plus other exposure, other options that you've got in the plan, you may be able to construct a portfolio that's a better fit for your unique circumstances than even the target-date fund alone could give.
So, it's very possible, and we do see some people doing this, doing this core-satellite type approach in their plans. It's very possible that people are doing that with the best of reasons in mind, and that is they're getting to a portfolio that's a much better fit for them. And they've got the target-date fund there to to do some work in terms of rebalancing and keeping in a broad exposure that's consistent with risk targets over time.
Benz: So, your target-date funds are pretty stripped down and so you're saying you see people adding some of these additional asset classes that aren't represented in your target-date plans?
Ameriks: Sure. Either additional asset classes or active management, if that's available through their plan. They may see a manager or a sector of the market that they themselves believe would add value given their circumstance and want to add that to their portfolio.
With the passive approach that we've got with our target-date funds, you know that we're not going to undo that or double up on that in a way that gives them an undesired risk exposure. So, at the end of the day nobody is a pure target-date fund investor. We all have assets that are outside of our retirement plans, and our spouses may have assets. We have other things. You've got to think about a portfolio holistically. A target-date fund remains an excellent choice as a base, but if you want to customize that yourself, absolutely. If you do that in a disciplined way, it can make a lot of sense.
Benz: So, let's briefly talk about customization. So say I'm looking at a target-date plan in my 401(k) and seeing the asset allocation. What are some reasons that I might nudge my equity weighting up or down using other investments in the plan?
Ameriks: Well, I think one that a lot of people will talk about, we get a lot of plan sponsors that talk about this in terms of customization, but it really does depend on the individual circumstance. So one thing may be the other assets that you've got outside of your plan that would give you reason probably to think about exactly how the target-date fund is allocated. If you're in a situation where your spouse is say a government employee and has a very guaranteed, strongly based pension income, you might be comfortable with taking a little bit more risk. If on the other hand they're a Silicon Valley executive where they have a lot of stock options, you may want to head in the other direction.
But ultimately, unfortunately, it comes down to the individual's situation and even an employer can't make that decision for everybody in a plan. Just because an employer offers a pension plan doesn't mean that every participant's accrued rights to that pension plan, especially these days. Or that they see that asset in the same way.
So it really does depend on your individual circumstances, and so we're big believers that target-date funds are great utility players in terms of building a core portfolio. But some of the advice services that are out there and managed account service that can take into account your other household assets, could really help.
Benz: Well, thanks John. It will be interesting to see how this whole issue of participant behavior unfolds in the target-date world. Thanks for sharing your insights.
Ameriks: Thanks for having me.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.
