Defined contribution retirement plans—such as 401(k)s—are a $6.7 trillion market today, covering some 90 million working Americans. Vanguard manages about $800 billion of those assets. That market has grown and improved significantly in the past decade, Vanguard Managing Director Martha King says, but there’s plenty of room to improve. What there doesn’t seem to be is a whole lot of demand—or use—for ETFs.
ETF.com: You took the leadership role at Vanguard's Institutional Investor Group about a year ago, working directly with employers offering retirement plans. What have you learned about how people invest for retirement?
Martha King: I’ve learned that the state of the defined contribution system is strong. There have been many positive changes that have occurred in the past decade for 401(k) plan participants. As a result, they’re better prepared for retirement. There's a lot that's going well in defined contribution plans.
ETF.com: More specifically, it's been 10 years since the Pension Protection Act became law. It was meant to help secure retirement for workers. How has the defined contribution, 401(k) space changed?
King: The big picture is that the law propelled plan sponsors to consider changes to plan design that really were in the better interests of their employees—changes that affected the investment lineups; changes that affected the benefits of encouraging employees to participate, and to increase their contribution once in the plan. You'll hear people talk about the autos—auto-enrollment, auto-escalation—and those things really didn't exist in a meaningful way before the Pension Protection Act.
With respect to investment lineup differences, the protections afforded plan sponsors led to changes in product offering that have, in turn, many more employees now putting their assets in a balanced portfolio. Go back 15 years, you'd see a lot of employees putting money as a default in a money-market-type fund, which is certainly a safe investment, but not the way you'd want someone to invest for retirement.
ETF.com: This law prompted better investment solutions in these retirement plans. What exactly are employers required by law to offer?
King: Plan sponsors get additional protections by putting a default investment option in place that meets several requirements—requirements that a money market fund would not meet. Before, plan sponsors would offer a long list of investments. Today, many have a default option, which in many cases is a target-date fund, or a series of target-date funds. The next layer of investment available oftentimes is an index tier. And then some plan sponsors have an active tier beyond that.
The point is that they’re trying to make it easier for participants to digest the choices they have in front of them. It's not just what investments are available, but their structuring and their presentation to participants. All of that helps get investors invested.
ETF.com: By offering a default target-date fund, employers are taking on the responsibility in terms of deciding what investments are appropriate for an employee. That seems counterintuitive in an era of do-it-yourself investing, and robo advisors.
King: Yes. I worked in the institutional division many years ago, before I started to run the Financial Advisor Services business for Vanguard, which I did for 13 years. And you’d have to go back quite some time now, say 15 years, but there was a belief that, with a long list of investment options and great participant education, you could get employees to make the right choices to have a diversified investment portfolio.
But what we've learned is that's not necessarily so. Actually, great plan design is a much better predictor of employees having appropriately diversified investment portfolios than abundance of product choice.
The beliefs that were once held in the defined contribution space are not held so dearly today. And I think employees are absolutely better off for it. But you're right, it is different from what you'll hear conveyed at the retail market.
ETF.com: What’s the biggest challenge to retirement investing today? Is it difficult to get employers to design great retirement plans?
King: We find plan sponsors are very receptive to discussions of better plan design, because we can come to that conversation armed with a great amount of data. It's pretty compelling.
But there's an opportunity for us as an industry, with respect to defined contribution plans, when it comes to coverage. It could be better. There are groups of individuals across the U.S. who are not covered today by a defined contribution plan either because of the size of the employer they work for, or the nature of what they do for a living.
Another issue is the savings rate. There’s been progress made where we see savings rates rising among plan participants. But there's room to grow. We would suggest that an individual have a savings rate of 15%. And that accounts for not just their own contribution, but their employer contributions as well. That’s not where the 90 million employees in DC plans are today.
ETF.com: How do you measure the performance of a DC plan? How do you know if your retirement plan is working?
King: We have a proprietary diagnostic tool that we use in institutional here. It's a plan evaluation index that we’ve created. We’ll score the plan, and we'll talk to the plan sponsor about our findings. Much of it has to do with plan design, as you would imagine. But it also has to do with participants' uptake.
In some cases, we see plan sponsors now doing annual re-enrollments to increase uptake. When they do an annual re-enrollment, they’ll re-enroll the participant into target-date funds. The participant has the option to reallocate the assets if they so choose, but what that annual re-enrollment does is captures any employees who have not been participating in the plan and brings them in. They can opt out.
It also takes those who may be investing poorly, not in a diversified way, and get them into a diversified investment solution.