Several years ago American Electric Power wanted to fix a few issues with its 401(k) plan.
In 2006, the plan's assets were invested in retail mutual funds, resulting in a 50- to 60 basis-point expense ratio. That meant about half of each percent of increase in assets was taken to pay for expenses. Plus, many participants also invested too conservatively or aggressively. About 35 percent of the company's $3 billion in plan assets were in a money market fund, and about 30 percent were in company stock.
American Electric Power knew it needed to resolve these issues, so it offered workers two new classes of professionally managed investment options: seven target date funds and a professional investment management service. Employees were taught which target date fund fit their age and comfort level for risk. Plus, Palo Alto, California-based investment management company Financial Engines introduced its Personal Asset Manager, providing a financial adviser to help workers construct portfolios.
Many plan sponsors such as American Electric Power are making a significant shift in offering professionally managed investment options including target-date funds, a new Vanguard Group Inc. survey shows. The investment management provider's survey, How America Saves 2012, shows 33 percent of 401(k) plan participants invested all their retirement money in one of these accounts as of Dec. 31, 2011. The percentage has nearly tripled since 2006, when it was at 12 percent.
"There is an evolution under way," says Jean Young, senior research analyst at Vanguard Center for Retirement Research. "With target date funds and managed account programs, participants are able to turn what is arguably the most difficult question of how to invest over to a professional investment manager."
Since 2006, American Electric Power's results have been dramatic, says Curt Cooper, director of benefits for the Columbus, Ohio-based electric company. First, taking advantage of the size of plan, the expense ratio has dropped between 15 to 30 basis points. Thanks to a new automatic enrollment program started in 2009, participation increased to 92 percent from 80 percent. Today employee assets in the money market fund have dropped to 23 percent from 35 percent, and only 10 percent of plan assets are in company stock.
"In 2006 we had a significant concern with the level of [participant] investment in company stock, and it had more to do with participants not being sufficiently diversified," Cooper says. "We took steps to address this."
Cooper attributes the positive changes to the professionally managed investment option change-up. Today, 15 percent of the 25,000 participants are solely invested in target date funds, and 30 percent are using Personal Asset Manager, Cooper says. The average account balance is a healthy $120,000.
"We are great at producing power, but most employees don't have the background you need to be a good investor. It's a complicated area," Cooper says. "Our participants understand that if they are invested in one target date fund, they are getting great diversification within that fund."
Breaking down the types of professionally managed investment options, Valley Forge, Pennsylvania-based Vanguard found nearly a quarter of participants invested all their money in one target date fund in 2011, while 6 percent chose a single traditional balanced fund and 3 percent were in a managed account advisory program like the one Financial Engines offers American Electric Power workers. The survey used data from 3 million participants in 2,000 401(k) plans using Vanguard's record-keeping services.
Compare these percentages to 2006 when only 4 percent of participants were in target date funds, 7 percent were in balanced accounts and just 1 percent in advisory programs. Vanguard's Young predicts 55 percent of all participants and 80 percent of new plan entrants will be in some kind of professionally managed investment option by 2016.
The use of target date funds will surge because more plan sponsors are realizing that they are a great solution to several issues, some experts say. Most off-the-shelf funds take an index-based approach, resulting in lower expense ratios ranging 17 to 19 basis points, Young says. Workers don't have to figure out their asset allocation and don't need to rebalance investments as they age and as their accounts change.
"The importance of portfolio construction is being driven by a professional," she says.
A key is offering different types of professionally managed investment options, says Patti Björk, director of retirement research at AonHewitt in Lincolnshire, Illinois. A target date fund might be a good initial investment for younger workers or for those with lower tenure, but professionally managed investment options might be better suited for workers with certain objectives, or older workers getting ready to retire.
"One product is not going to meet all participants' needs," Björk says. "We like to see all these products offered."
The Vanguard study showed that participants contributed an average of 7.1 percent, up slightly from 6.9 percent in 2010. When adding employer matches, average contributions remained unchanged at 10.4 percent in 2011.
The results are encouraging, but more could be done—especially in getting employees to contribute at a higher rate, experts agree. Vanguard recommends workers save 12 percent to 15 percent of pay or more.
"While we are making great inroads on asset allocation, we need to get people to save more than 10 percent," Young says.
Patty Kujawa is a writer based in Milwaukee. Comment below or email firstname.lastname@example.org.