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Automatic Features Growing in Number, Influence

‘Autos’ are proliferating on the retirement superhighway, recent studies report. Auto-enrollment, auto-escalation, auto-investment — all are growing in number of users and in their influence.

Automatic Enrollment

In “How America Saves, 2017,” a Vanguard study based on 2016 DC plan data, the firm found that adoption of auto-enrollment in the last 10 years has grown by 300%. So what does that translate to? In 2016:

  • 45% of Vanguard plans used auto-enrollment;

  • 64% of new plan entrants were automatically enrolled;

  • just over 60% of all contributing participants were in plans with auto-enrollment;

  • slightly more than one-third of contributing participants had joined the plan through auto-enrollment; and

  • auto-enrollment also applied to eligible nonparticipants who were not new Vanguard hires in half of the plans that had that feature.

Vanguard’s findings echo those of the Plan Sponsor Council of America (PSCA) in its 59th Annual Survey, which reflected the 2015 plan-year experience of 614 DC plan sponsors. Almost 58% of plans overall in that study offered auto enrollment; 66.7% of large plans did so, as opposed to 25.5% of plans with fewer than 50 participants.

Automatic Escalation

Vanguard reports that two-thirds of its plans with auto-enrollment have also implemented automatic annual deferral rate increases.

In 2016, the report says, automatic increases narrowed the spread between deferral rates for participants in voluntary enrollment plans and deferral rates for participants in automatic enrollment plans to 0.2 basis points. Participants in voluntary plans had a deferral rate of 6.3%; the rate for participants in automatic plans was 6.1%.

Almost all — 99% — of all Vanguard plans with auto enrollment default participants into a balanced investment strategy, the report found.

Automatic Investment Plans

Automatic investment plan structures around the world “work wonders at keeping investors on track and preventing them from unwise market-timing moves,” according to Morningstar’s 2017 “Mind the Gap” study.

Noting that South Korea, Australia and the United States had positive gaps in their variations of automatic plan features, the report contends that “[s]eeing this work in three different investment cultures is a strong endorsement for the practice worldwide.”

Morningstar expanded its 2017 study from the United States and Europe to its first-ever global look at investor returns across markets and asset classes. Though the five-year investor returns gap ranged from -1.40% to 0.53% for year-end 2016, the authors point out that two common themes emerged in this year’s study: investment vehicles that required systematic investment produced better returns, while lower-cost funds also produced better returns and a smaller investment returns gap.

Meanwhile, in the United States and Europe, Morningstar found declining gaps between investor returns and total returns. The investor returns gap in the United States fell to 37 basis points annualized from 54 basis points during the 10-year period ended 2016.

In reviewing the so-called “Do Nothing Portfolio,” the report notes that performance for this measurement was mixed around the globe, but it performed “surprisingly well” in the United States. For example, the typical diversified equity fund investor would have had a return of 5.31%, topping the 5.15% average fund return and the 4.36% average investor return, the report shows. For U.S. bond funds, the Do Nothing return was 4.30%, compared with 2.99% for the average investor return and 3.72% for the average fund return.

When looking at fees, the authors generally saw investor returns decline as they moved from low-cost to higher-priced returns, with the gap growing as they moved up in price. Factors at work could be higher-cost funds taking on greater risks to overcome their higher fees, which may lead to poor timing decisions. In addition, there likely could be a combination of savvy investors and responsible fund companies in lower-cost funds and less-responsible investors and fund companies in the high-cost zone, the authors suggest.

While there has been a strong suggestion in the past that more volatile equity funds lead to worse investor returns because they are harder to time and produce emotional responses, the report shows that this was not fully the case for some markets. The authors note the possibility that a relatively smooth market environment over the past five years has rewarded volatility and understates the effect.