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®

S A V E S

How

A Report on Vanguard Defined Contribution Plans

2 0 0 2

America

Once a minor player in the retirement savings system, defined contribution plans, in

particular 401(k) plans, have taken center stage as the dominant form of retirement savings

for America’s workers. Today nearly 60 million employees participate in defined contribution

plans, and industry assets total $2.2 trillion. By 2030, researchers expect that defined

contribution plans will be paying more to the baby boom generation than Social Security.

The Vanguard Group is a leader in the defined contribution marketplace

with nearly $300 billion in retirement assets. We offer plan sponsors invest-

ment management, recordkeeping, and education services. Today we serve

more than 1,300 plan sponsors and nearly 3 million participants.

As an industry leader, Vanguard recognizes that it’s important to have a

detailed understanding of defined contribution plans and the role they play

in the U.S. retirement system. To this end, we’ve prepared the 2002 edition

of How America Saves: A Report on Vanguard Defined Contribution Plans. This

report provides an assessment of defined contribution plans and participant

behavior based on Vanguard recordkeeping data and other sources. It also

offers an update on the broader defined contribution savings system.

We hope our report will serve as a valuable reference tool, and that our

observations will prove useful as your organization continues to evaluate

its retirement offerings.

Sincerely,

F. William McNabb III

Managing Director

Institutional Investor Group

September 2002

4 Highlights

8 part one

Retirement Plans andthe U.S. Workforce

10 The U.S. Workforce

13 Plans, Participants, and Assets

17 Retirement Plan Coverage

22 The Incomes of Older Americans

26 part two

Vanguard Defined ContributionPlans: Current Features

28 Participation Rates

31 Savings Rates

33 Participant Investment Decisions

37 Account Balances

40 Plan Investment Options and Decisions

47 Exchange Activity

49 Participant Education and Advice

52 Access Methods and The Internet

55 Plan Loans

59 In-Service Withdrawals

60 Plan Distributions and Rollovers

64 part three

Insights and Strategies

66 Boosting Participation and Savings Rates

73 How Much Should Workers Be Saving?

78 Restrictions on Company Stock

83 “Money Attitudes” and RetirementCommunications

89 Participant Trading Behavior: A Longer-Term View

93 Methodology

94 References

96 Acknowledgments

see following pages for Highlights . . .

C O N T E N T S

Total private sector retirement plan assets reached $4.1 trillion in 2001 and will likely grow at single-digit rates through 2003 (assuming single-digit market returns).Defined benefit assets constituted 46% of the total; defined contribution assets,54%. At year-end 2001 there were 23 million participants in defined benefit plansand 57 million participants in defined contribution plans. Page 14.

401(k) plans now account for nearly three-quarters of all defined contribution planassets, more than 80% of all defined contribution plan participants, and nearly 40% of all private sector retirement assets. Page 15.

Just less than half of U.S. workers were covered by employer retirement plans atyear-end 2001: 6% had defined benefit plan coverage only; 28% had defined contri-bution plan coverage only; and 15% had coverage from both types of plans. Page18.

For older Americans, Social Security remains the most prevalent source of income:9 of 10 older Americans received Social Security income in 2000. Six of 10 olderhouseholds had income from savings; 4 of 10, income from employer plans. Forlow-income households, Social Security accounted for 8 of every 10 dollars ofincome; for high-income households, income came from a mix of Social Security, personal savings, employer plans, and work earnings. Page 22.

Vanguard average plan participation rates declined from 79% in 1999 to 76% in2001, a pattern similar to that reported by other industry sources. Likely reasonsinclude the slowdown in the U.S. economy and the impact of declining stock priceson new plan enrollment. Page 28.

Retirement Plansand the U.S.Workforce

Participation andSavings Behavior

Highlights

From 1999 to 2001, Vanguard average plan savings rates also declined by 1% to just more than 7%. As with participation rates, likely reasons include the economic slowdown and the impact of falling stock prices on savings behavior.Some data on participant deferral rates in the first half of 2002 suggested risingsavings rates, possibly in response to improved economic conditions and pension reform. Page 31.

The main tools for boosting plan participation and savings rates remain specificplan features (company match, loans) and participant communications. New strategies include plan design features such as automatic enrollment and automatic savings (SMarT) plans, as well as new education techniques such as personaliza-tion and “money attitudes” research. New studies also underscore the importanceof peer group dynamics in determining savings behavior. Page 66.

Despite a two-year decline in U.S. stocks of –20%, the average asset allocation toequities among Vanguard participants fell only slightly, from 78% in 1999 to 76% in 2001. Falling asset values were offset by ongoing contributions to equities.Contribution allocations to equities remain virtually unchanged, at 81% of new contributions in 2001. Pages 33 and 34.

Although Vanguard participants maintained high allocations to equities in the faceof a sharply declining stock market, the average Vanguard participant’s account balance fell by only 1% from 1999 to 2001. The typical (median) account balanceactually rose by 5% during the period. Again, new contributions offset the impact of declining asset values. These results may explain participants’ continuedcommitment to a buy-and-hold strategy, despite the worst decline in U.S. stockprices in a quarter century. Page 37.

Highlights

Impact of the Bear Market in U.S. Stocks

In any given year, few participants trade (i.e., exchange monies among investmentoptions in their employer’s plan). In 1999 only 17% of participants undertook anyinvestment exchange; in 2001 that number fell to 14% of participants. Page 47.

While fewer participants are trading, those who do trade are becoming increasinglylike-minded, with a preference for moving assets into fixed income investments.In 2001 an average of 2.5% of Vanguard net recordkeeping assets was shifted from equities to fixed income investments. While still modest, it was more than double the shift of 0.9% of average assets into fixed income investments in 1999. Page 48.

Company stock accounted for 14% of total defined contribution assets at Vanguard—and 25% of total assets among plans offering company stock as an investment option. These concentration levels remain somewhat below industry averages. Page 78.

The types of restrictions employers imposed on company stock are closely linkedwith the decision whether to make employer contributions in company stock or cash. Employers making stock contributions are more likely to impose restrictionson participants’ ability to diversify those contributions. Employers making cash con-tributions are more likely to have no restrictions at all or impose caps or maximumsin an effort to avoid concentrated stock holdings by participants. Pages 78 to

Vanguard participants are divided into three segments based on their degree ofinvolvement with their retirement accounts. Frequent contactors represented 22%of the Vanguard participant population in 2001; they contacted Vanguard an aver-age of 38 times per year, through the Web, a voice-response unit, or a telephoneassociate. Infrequent contactors constituted 30% of the plan population; they

Highlights

The Role ofCompany Stock

Participant Account Activity

Participant TradingActivity

81.

contacted Vanguard an average of four times per year. Just less than half of participants (48%) were noncontactors—they relied exclusively on quarterly accountstatements for information about their retirement plan accounts. Page 52.

Frequent contactors tend to be 45-year-old males with high account balances andhigh household incomes. According to Vanguard surveys of national plan partici-pants, these demographic elements are similar to those for frequent stock marketcheckers and frequent traders. Page 52.

Low levels of participant involvement—both reflected in account access data and in participant trading activity—seem appropriate in light of median account balances ($15,000) and a limited number of actual investment holdings (a median of three options). Page 42.

At a national level, an estimated 30% of preretirees are well prepared for retire-ment, 30% are potentially secure, and 40% are at risk. 4.

A participant earning $50,000 per year and covered only by a defined contributionplan would need to save 15% of income (both in employer and employee contribu-tions) over 30 years to ensure adequate retirement savings. For a participant withboth defined benefit and defined contribution coverage, the target savings ratewould be 9%. Based on these benchmarks, current defined contribution savingsrates appear to be too low. Page 77.

Other factors driving higher retirement savings include: a possible reduction inSocial Security benefits; the prospect for higher out-of-pocket Medicare and otherhealth care costs; increased life expectancy; and the additional savings needed to “self-fund” retirement income streams from lump-sum distributions. Page 75.

Highlights

Retirement Savings Adequacy

Retirement Plans and the U.S. Workforce

P A R T O N E

The U.S. retirement savings system rests on three legs. The first, Social Security, pro-vides income payments to older Americansand disability payments to workers. Thisdefined benefit program is mandatory andnearly universal. The system is publiclyfinanced through employer and employeepayroll taxes.

The second leg consists of an

extensive array of employer-

sponsored retirement plans.

Sponsorship of such plans is vol-

untary, and U.S. tax law provides

incentives to encourage plan

adoption. The principal sponsors

are private sector employers;

other important sponsors

include unions, nonprofit organi-

zations, and the public sector.

Defined contribution plans are

now the most prevalent type

of plan, though defined benefit

plans remain quite important for

employees of large companies,

union members, and public

sector workers.

The third leg of the U.S.

system is individually controlled

private retirement savings. Tax

incentives are granted to several

types of personal retirement

savings, including individual

retirement accounts (IRAs) and

fixed and variable annuities.

In this section we provide an

overview of key aspects of the

U.S. retirement system, with an

emphasis on employer-sponsored

retirement plans for private sec-

tor workers. This section covers:

• An overview of the U.S.

workforce in 2001.

• Size and scope of private

retirement plans.

• Retirement plan coverage.

• Income sources for today’s

older Americans.

The U.S. workforce has undergone

several dramatic changes over the past

quarter century. The changes outlined

below provide a broader context for

understanding retirement plan cover-

age and the shift from defined benefit

to defined contribution plans over

the period.

Employment

In 2001 the U.S. population totaled

285 million, and the U.S. workforce

reached 142 million (see chart 1).

Today, nearly 80% of jobs in the U.S.

workforce are in the private sector;

15% are in the public sector; and 2%

are in agriculture.

Over the past quarter century, private

sector employment has grown more

rapidly than public sector employ-

ment (see chart 2). From 1975 to

2001, private payrolls grew from 63

million to 110 million workers at an

annualized growth rate of 2.3%.

During the same period, government

payrolls expanded from 15 million to

21 million workers—an annualized

growth rate of 1.4%.

Part 1 Retirement Plans and the U.S. Workforce

1. Current U.S. Workforce 2001

Individuals

U.S. population

Civilian labor force

284.9

141.8

Source: U.S. Census, Department of Labor, 2001.

Composition of U.S. Workforce (in millions)

Individuals

Private sector (nonfarm)

Government

Agriculture

Unemployed

Other

110.2

21.1

3.1

6.7

0.7

Percentage

78%

15%

2%

5%

0%

Composition of Civilian Labor Force (in millions)

2. Growth of U.S. Workforce 1975–2001

Nonfarm Workers (in millions)

Public sector payrolls (+1.4% per year)

Private sector payrolls (+2.3% per year)

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

0

20

40

60

80

100

120

Source: Department of Labor, 2001.

The U.S. Workforce

Employment sectors

Sector employment has changed sub-

stantially during the past 25 years,

with the most significant transforma-

tion being a shift from manufacturing

to service sector jobs. In 1975 both

the manufacturing and service sectors

employed about the same percentage

of the workforce—24%. By 2001,

however, service jobs were almost

three times as plentiful as jobs in

manufacturing with manufacturing

jobs shrinking to 13% of the work-

force, and service jobs growing to

37% (see chart 3).1

This change has occurred because of

dramatically different growth rates in

the two job sectors. Since 1975 the

number of manufacturing jobs has

been basically flat, shrinking –0.3%

per year. Meanwhile, the number of

service jobs has surged, growing

4% per year.

Other job sectors show smaller

changes. Public sector employment,

as well as jobs in the transportation

and public utilities sectors, grew more

slowly than other parts of the labor

market. As a result, since 1975 jobs

in these combined sectors have fallen

from 25% to 21% of total employ-

ment. Employment in other areas—

wholesale and retail trade, construc-

tion and mining—has remained

essentially unchanged at 28% of

the workforce. Within this category,

job growth was somewhat stronger

in retail trade and construction,

while mining jobs fell.


3. Sector Employment 1975–2001

Percentage of Employment Per Sector

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

0%

20%

40%

60%

80%

100%

Manufacturing

Services

Government, transit, and utilities

Other goods and services


1 The term “manufacturing” here includes durable

and nondurable goods manufacturing as defined

by the Department of Labor (DOL). “Services”

includes the DOL’s “service” category and jobs in

the finance, insurance, and real estate sectors.

Thus, the term “services” is broader here than

the standard DOL definition.

Work arrangements

Full-time work remains the most

common type of employment

arrangement in the U.S. Three-

quarters of workers are engaged

in full-time work (see chart 4).

An additional 15% are engaged

in traditional part-time work.

Nearly 13 million workers, or just

less than 10% of the workforce, are

employed in what are termed “alter-

native work arrangements” (see again

chart 4).2 These jobs are structured

somewhat differently than traditional

full-time or part-time work.

Workers in alternative work arrange-

ments include3:

Independent contractors (6.4% of

the workforce)—freelance workers

who typically acquire clients on their

own. Examples include management

consultants, freelance writers, or self-

employed trades people.

On-call workers (1.6%)—workers who

are called to a job as needed by vari-

ous employers. Their work may last a

day or two or extend to several weeks.

They include construction workers

hired through a union hall, substitute

teachers, or on-call nurses.

Temporary-help agency workers (0.9%)—

any workers paid by a temporary-

employment agency. The typical tem-

porary worker is the “temp” office sec-

retary, but this category also includes

jobs such as temporary accountants

or paralegals.

Contract workers (0.5%)—workers

employed by a contracting company,

which provides another organization

with workers on a long-term basis.

The workers of the contracting

company typically work for a single

client and often at the client’s work

site. Examples include employees

of food service, security, or computer

services companies—activities

typically “outsourced” by the client

organization to the contracting firm.


4. Work Arrangements in 2001

Employed Workforce135.0 million

75.2% Full-time101.5 million

9.4% Alternative Work Arrangements12.7 million

Source: Department of Labor, 2001; Vanguard estimates.

15.4% Part-time20.8 million

2 This information has been drawn from

Polivka, 1996.

3 Separate from the definition of full-time, part-

time, or alternative work; another 2% to 4% of

the workforce (three million to six million workers)

is classified as “contingent”—workers who expect

their employment to end in the foreseeable future.

Union membership

Union members accounted for 13.5%

of the U.S. workforce in 2001 (see

chart 5). The rate of unionization

has remained steady in recent years,

although it has declined from 20.1%

in 1983 when comparable statistics

were first collected.

Nearly 4 in 10 public sector workers

are union members. In local govern-

ment, heavily unionized occupations

include teachers, firefighters, and

police. In the private sector, less

than 1 in 10 workers is a member

of a union. Private sector unions

are more prevalent in transportation,

public utilities, construction, and

manufacturing. One explanation for

the decline in union membership

has been the shift away from manu-

facturing jobs, as well as slower job

growth in the transportation, public

utilities, and government sectors—

sectors where unions typically

dominate employment.

The system of private, employer-

sponsored retirement plans is an

essential component of the U.S. retire-

ment savings system. In this section

we examine the current system as

measured by total invested assets, plan

participants, and the number and

types of plans. We also document

the shift from defined benefit (DB)

to defined contribution (DC) plans,

and in particular the growth of

401(k) plans as the dominant form

of DC plan.

Our analysis focuses on retirement

plans sponsored by private sector

employers, as nearly 8 in 10 U.S.

workers are employed in the private

sector. The data includes only wage

and salaried workers; self-employed

workers are not included in these

totals. This section should be read

in conjunction with the next section

on retirement plan coverage.


5. Union Membership in 2001

Wage and Salary Workers Who Are Also Union Members

EntireWorkforce

Public Sector

Private Sector

Members (in millions)

Percent

16.3

13.5%

7.2

37.4%

9.1

9.4%


Plans, Participants, and Assets

Overview

As of 2001, based on Vanguard esti-

mates4, private sector retirement assets

totaled $4.1 trillion, with $1.9 trillion

invested in DB plans and $2.2 trillion

in DC plans (see chart 6, top panel).

Although they are not formally part

of the employer-based retirement

system, IRAs are the recipients of

rollovers from both DC and DB

plans, and so a portion of IRA assets

comes from employer-sponsored

plans. As of 2001 IRA assets stood

at $2.6 trillion.5

Retirement Plans Overview

Based on our estimates (which

assume single-digit market returns

in 2002 and 2003), asset levels in

both DB and DC plans will continue

to grow at modest rates through

2003. Continuing the trend of the

past two decades, DC and IRA assets

are expected to grow at a faster rate

than DB assets.

As of 2001 there were about 80 mil-

lion workers participating in private

sector retirement plans (see chart 6,

second panel). A worker may be in

multiple plans, and so the actual

number of private sector workers cov-

ered by an employer-sponsored plan

is lower (see page 17). Of the private

sector workers in retirement plans,

about 70% of the total, or 57 million,

were in DC plans; about 30%, or 23

million, were in DB plans.

In 2001 there were more than

700,000 private sector DC plans,

compared with more than 50,000

DB plans (see chart 6, third panel).

Both in terms of active participants

and number of plans, DC plans

are expected to continue to grow,

while DB plans are expected to

stagnate or continue their historical

decline, albeit at a much slower

rate than in the past.


4 Data through 1998 is drawn from DOL retirement

plans data, issued by the Pension Benefits and

Welfare Administration. Data for 1999 through

2003 is based on Vanguard estimates.5 While the percentage of IRA assets due to

employer rollovers is uncertain, 44% of IRA

account holders indicated that a portion of their

IRA assets are derived from an employer-

sponsored retirement plan. See ICI, 2002.

6. Retirement Plans Overview 2001–2003

2001Private Sector 2002 2003

AnnualGrowth

Rate

4%7%

5%

6%

0%4%

2%

–1%4%

4%

8%6%6%8%

1,894 2,166

4,060

2,602

23,000 57,100

80,100

52,000 736,000

788,000

1,603 45,900 70,600

392,800

$ $

$

$

$

1,951 2,275

4,226

2,732

22,900 58,900

81,800

51,000 765,500

816,500

1,706 47,700 73,400

424,200

$ $

$

$

$

2,044 2,457

4,501

2,951

22,800 61,200

84,000

50,500 796,100

846,600

1,867 51,500 79,200

458,200

$ $

$

$

$

Assets ($ billions)Defined BenefitDefined Contribution

Total

IRA Assets

Participants (thousands)Defined BenefitDefined Contribution

Total

PlansDefined BenefitDefined Contribution

Total

401(k) Plans* 401(k) Assets ($ trillions) 401(k) Participants (thousands) 401(k) Eligibles (thousands)** 401(k) Plans

* 401(k) data is subset of defined contribution data. ** 401(k) eligibles are estimated based on weighted participation rate of 65%. Source: Vanguard estimates; Department of Labor; Federal Reserve. 2002 and 2003 forecasts based on balanced index market return of 5% in 2002 and 8% in 2003.

Although they are already included

in the totals for DC plans, we have

separately estimated assets, partici-

pants, and 401(k) plans (see chart 6,

bottom panel). In 2001, 401(k) assets

stood at $1.6 trillion. Out of an esti-

mated 70 million workers eligible

for 401(k) plans, nearly 46 million

were active participants in their plans.

And the total number of 401(k)

plans approached 400,000.

By several measures, 401(k) plans

are now the dominant form of DC

retirement plan, more significant than

traditional DC plans such as stand-

alone profit-sharing, money purchase,

or employee stock ownership plans

(ESOPs). Today, 401(k) plans

account for:

• More than half of all DC plans.

• Nearly three-quarters of all DC

plan assets.

• More than 80% of all DC

plan participants.

Perhaps most significantly, 401(k)

plans now account for nearly 40%

of all private sector retirement plan

assets, DB and DC combined—a

total of $1.6 trillion in 401(k) plans

versus a combined $4.1 trillion in

all DB and DC plans.

Assets

Since 1985 DC plan assets have

grown at more than twice the rate

of DB plan assets (see chart 7).

DC plan assets have expanded at an

11% annualized rate, compared with

a 5% growth rate for DB plan assets.

Much of the growth in DC assets

has come from 401(k) plans, which

have surged at a compound rate

of 16% per year since 1985.

Similarly, IRA assets grew at double-

digit rates during the same period,

(see chart 8) expanding from $236

billion to $2.6 trillion since 1985.

This reflects an annualized growth

rate of 16% per year.


7. Plan Assets 1985–2001

Assets of Private Sector Retirement Plans (in billions)

DB +5% per year

DC +11% per year

401(k) +16% per year

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Note: 401(k) is a subset of defined contribution data.Source: Department of Labor through 1998; Vanguard estimates thereafter.

$0

$500

$1,000

$1,500

$2,000

$2,500

8. IRAs 1985–2001

IRA Assets (in billions)

Source: Federal Reserve and Vanguard estimates.

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

1986

1985

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

IRAs +16% per year

Participants

Since 1985 DC plan participants have

grown from 33 million to 57 million,

a compound growth rate of about 3%

per year (see chart 9). Within this

category, 401(k) plan participants

have expanded at a 10% growth rate.

In 1985 3 in 10 DC plan participants

were in 401(k) plans; by 2001, nearly

8 in 10 were. The number of DB

plan participants fell from 29 million

in 1985 to 23 million in 2001—

a decline of 1% per year over the

period. This in part reflects the

shift in employment away from sec-

tors, such as manufacturing or the

government, where DB plans have

traditionally predominated.

Plans

Similar patterns are reflected in the

changing number of DB, DC, and

401(k) retirement plans (see chart

10). The number of DB plans has

fallen from more than 170,000 in

1985 to about 52,000 in 2001.

Meanwhile, the number of DC plans

has grown, and in particular 401(k)

plans have expanded at double-digit

rates. In 1985 only 6% of DC plans

were 401(k) plans; by 2001, more

than half were.


9. Plan Participants 1985–2001

Private Sector Active Retirement Plan Participants (in thousands)

DB –1% per year

DC +3% per year

401(k) +10% per year1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Note: 401(k) data is a subset of defined contribution data.Source: Department of Labor through 1998; Vanguard estimates thereafter.

0

10,000

20,000

30,000

40,000

50,000

60,000

10. Plans 1985–2001

Number of Private Sector Retirement Plans

DB –7% per year

DC +3% per year

401(k) +17% per year

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Note: 401(k) data is a subset of defined contribution data.Source: Department of Labor through 1998; Vanguard estimates thereafter.

0

200,000

400,000

600,000

800,000

Coverage is the term used to describe

the number of workers eligible for,

and participating in, an employer-

sponsored retirement savings plan. It

is an important measure of the success

of the U.S. retirement savings system,

as the system relies on employment-

based retirement plans and private

savings to supplement benefits from

the Social Security system.

The term “pension coverage” is still

widely used, though it is now some-

thing of an anachronism given the

shift away from DB plans (pensions)

to DC plans (savings plans) over

the past quarter century. In this sec-

tion we summarize retirement plan

coverage both currently and histori-

cally, and offer some perspective

on how coverage varies across the

U.S. workforce.

Given that nearly 8 in 10 jobs are

in the private sector, our focus is on

private sector wage and salaried

workers (excluding the self-employed).

Pension coverage rates for the

public sector, as we note below, are

comparable to those found among

large private employers. Our analysis

addresses coverage rates, the number

of active workers covered by a private

plan—as opposed to sponsorship

rates, the number of employers

offering a retirement plan.6

Current coverage

According to our own estimates based

on historical data from the U.S.

Department of Labor, 49% of private

sector salaried and wage workers

were participating in a retirement

plan in 2001, and 51% were not

(see chart 11).

The dominant type of retirement

plan is a DC plan. More than 4 in 10

private sector workers participate in

a DC plan—28% participate solely

in a DC plan, and another 15% are

in both a DB and DC plan. In terms

of DB coverage, about 2 in 10 private

sector workers have such coverage—

6% of workers have only a DB plan,

and, again, 15% have both a DB

and a DC plan.


6 The plan sponsorship rate, the percentage of

employers offering a retirement plan to workers, is

generally higher than plan coverage rates by more

than ten percentage points. The sponsorship rate

indicates only whether an employer has established

a retirement plan, regardless of eligibility rules or

participation by the employee. The coverage rate

reflects the actual number of employees who are

eligible for a plan and who are covered by it

(including, in voluntary 401(k) plans, those who

actually participate in the plan).

11. Current Private Sector Coverage 2001

15% DB and DC


51% Not covered

28% DC only% DC only

6% DB only

Retirement Plan Coverage

Historical coverage

Over the past quarter century, pen-

sion coverage has remained virtually

unchanged, at just under half of the

private sector workforce, despite

the dramatic shift from DB to DC

plans (see chart 12). In 1975 the

dominant form of pension plan cover-

age was DB-only. For 31% of the

private workforce, the only type of

retirement plan offered was a DB

plan. Another 8% of workers had

both DB and DC plans. At that time,

only 6% of private sector workers

were covered by DC-only plans,

which at the time did not include

401(k) plans.

With the introduction of 401(k)

plans in the early 1980s, coverage

by DC plans soared. The number

of workers covered by DC-only plans

nearly quintupled, from 6% to 28%

of the private sector workforce.

And the number of dual-coverage

participants—those covered by both

DB and DC plans—nearly doubled,

from 8% to 15%. Meanwhile,

coverage by stand-alone DB plans

declined sharply, from 31% to 6%

of the workforce.

In simple terms, over the past quarter

century, the rates of DB and DC

coverage have essentially traded

places. In 1975 about 4 in 10 private

sector workers (39%) had DB plan

coverage, either as a stand-alone DB

plan or in combined DB-DC cover-

age. By 2001, DC plans covered more

than 4 out of 10 (43%) workers.

In 1975, DC plans covered less than

2 out of 10 (14%) private sector

workers; by 2001, DB plans covered

2 in 10 workers (21%). The dominant

type of DC plan changed as well,

away from standalone profit-sharing

and ESOP programs to 401(k) plans,

sometimes in combination with

profit-sharing or ESOP features.


12. Historical Private Sector Coverage 1975–2001

Percentage of Coverage

DB Only DC Only

DB and DC

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001


5%

10%

15%

20%

25%

30%

35%

Variations in coverage

Pension coverage depends on a num-

ber of employment-related factors

(see chart 13). These include firm

size, employment sector, employee

skill grade, and the type of work

arrangement (full-time, part-time,

alternative). As a general rule,

coverage rates are higher among:

• Public sector and large private

sector firms.

• Manufacturing, transportation, pub-

lic utilities, and financial services.

• Professional/technical employees

and union members.

• Full-time workers.

At the other extreme, coverage

rates are lowest among small firms,

among sectors like construction and

retail sales, and among part-time,

on-call, temporary, and independent

contract workers.


13. Variations in Coverage 1999

Percentage of Private Sector Salary and Wage Workers Participating in an Employer Retirement Plan—by Economic FactorOverall Average: 48%

Firm Size/Type* SectorType of Employees

Work Arrangement

Above-average coverage

Near-average coverage

Below-average coverage

Very large firms (81%)Public sector (80%)Large firms (70%)

Medium firms (57%)

Small firms (34%)

Manufacturing (68%)FIRE (62%)**Transportation and public utilities (59%)

Wholesale trade (53%)Services (45%)

Construction (39%)Retail trade (30%)

Full-time (56%)

Contract workers (48%)***R

On-call workers (31%)***Part-time (21%)Temp help (8%)***Independent contractors (2%)***

Union (79%)Professional/technical (69%)

Clerical/sales (45%)R

Blue collar/service (42%)

Economic Factor (Coverage Rate)

* Very large firms: 2,500 or more employees; large firms: 500–2,499 employees; medium firms: 100–499 employees; small firms: 1–99 employees. ** Finance, insurance, and real estate sector. *** 2001. Note: Below- and above-average defined as more than 10% below- or above-average. Source: Department of Labor, 1999, 2001.

Another way to look at variations

in pension coverage is by the

demographic characteristics of

workers (see chart 14).7 Not surpris-

ingly, workers who are older, have

average or above-average incomes,

or who have college or professional

training are more likely to be in jobs

with retirement plans. Meanwhile,

younger workers with low incomes

and less education are less likely

to be in jobs with retirement plans.

Coverage among women and men is

about equal—although, importantly,

this figure only measures those women

in the formal workforce. Because

more women than men work in the

home and fall outside the employ-

ment-based pension system, the

pension coverage rate for women in

the aggregate is lower than that for

men. White workers have somewhat

higher rates of coverage than black

workers or other races; perhaps the

most significant disparity is the low

rate of coverage for Hispanic workers.


7 This demographic analysis is based on the public

and private sector workforce that is full-time and

full-year, age 18 to 64. Because full-time and public

sector employees have high rates of coverage, the

average coverage rate for this group is 61%. This

figure is used to make comparisons of above- and

below-average coverage.

14. Demographic Variations in Coverage 1999

Percentage of Public and Private Workers, Full-time and Full-year, Participating in an Employer Retirement Plan—by Demographic FactorOverall Average: 61%

Age Income Education

Race

Above-average coverage

Near-average coverageV

Below-average coverage

Age 45–54 (72%)Age 55–64 (68%)

Age 35–44 (61%)Age 25–34 (54%)V

Age 21–24 (33%)Age 20 and under (17%)

$50K+ (82%)$40–$49K (78%)$30–$39K (70%)

$20–$29K (50%)

$15–$19K (38%)$10–$14K (26%)

Gender

Male (61%)Female (60%)

White (65%)Black (56%)Other (55%)

Hispanic (38%)

Graduate/professional (81%)Bachelor’s degree (72%)

Some college (62%)High school (55%)

Less than high school (32%)

Demographic Factor (Coverage Rate)

Note: Below- and above-average defined as more than 10% below- or above-average. Source: Department of Labor, 1999; EBRI, 1999.

Boosting plan coverage

These statistics convey some of the

challenges involved in boosting cover-

age rates and strengthening the role

of employer-based plans in the U.S.

retirement savings system. For exam-

ple, small businesses (companies with

less than 100 employees) employ

more than 4 out of 10 private workers

in the U.S. But only a third or so of

small businesses are able to offer an

employer plan. Surveys of business

owners indicate that there are two

main reasons why they don’t offer a

retirement plan—uncertain company

revenues and workers’ preferences

for wages.8

When an employer offers an employ-

ee-voluntary program like a 401(k)

plan, coverage rates will also depend

on workers’ decisions to join the plan.

Retirement plan coverage is lower for

workers who are younger, who have

less income, or who are less educated.

One reason is that these workers are

more likely to be in jobs that lack

retirement plan coverage. But another

reason is that workers may choose not

to participate—whether because of

low income and an inability to save,

or a lack of understanding or aware-

ness of the plan and its benefits.

There are two challenges to boosting

private pension coverage in the

U.S.: encouraging firms, particularly

medium- and small-sized businesses,

to take on the costs of plan sponsor-

ship; and, in the case of voluntary

programs like 401(k) plans, encouraging

workers, particularly lower-income

workers, to take on the costs of

contributing to their plan.


8 EBRI, 2002.

Another way to examine the U.S.

retirement savings system is from the

perspective of the benefits paid today

to older Americans. In 2001 more

than 35 million Americans—about

12% of the population—were age 65

or older. Not all of these individuals

were “retired” in the traditional

sense—that is, individuals who had

left their primary occupation. But age

65 remains a traditional demarcation

point between the active workforce

and the retired population in the U.S.

In this section we look at the current

incomes of those age 65 and older

in 2000. This data is drawn from

an analysis conducted by the Social

Security Administration based on

a survey by the U.S. Census Bureau.9

Sources of income

Social Security remains the most

prevalent form of income earned

by older Americans. Nine out of 10

older Americans received benefits

under the program in 2000, the latest

year for which data is available

(see chart 15). Six out of 10 older

Americans reported income from

their personal savings; about 4 in 10

said they received income from an

employer retirement plan, both public

and private sector. About 1 in 5

older Americans had salary or wages

from work.

Two caveats about these results:

First, with the shift from DB to DC

plans, the distinction between person-

al savings and employer plans has

become blurred. The category

“employer plans” includes pension

payments received from a DB plan.

But it may not capture DC plan

savings, depending on how the indi-

vidual replied to the Census Bureau

survey. Workers who roll over DC

plan savings (or DB lump sums)

to IRAs may classify these monies

as savings. Thus, the finding that

4 out of 10 older Americans receive

money from an employer plan may

refer largely to DB pension payments

and some, but not all, DC monies.


15. Income Sources for Older Americans in 2000

Percentage of Older Americans Receiving Income from a Given Source

90%

5%

22%

41%

4%

59%

SocialSecurity

Personal Savings

EmployerPlans

Veterans’Benefits

PublicAssistance

WorkEarnings

Source: Social Security Administration, 2002.

Source

0%

20%

40%

60%

80%

100%

9 See Social Security Administration, 2002. This data

is based on Social Security “aged units”—married

couples with at least one member 65 and older or

single individuals age 65 and older. Throughout

this section we use informal terms like “older

Americans” or “households age 65 and older”

instead of the more technical “aged units.”

The Incomes of Older Americans

Second, this survey includes all

Americans 65 and older, whether they

are working or retired. So, for an item

like “work earnings,” the results shown

include individuals still in the work-

force, as well as individuals who con-

sider themselves retired, but who also

have chosen to work in retirement.

Shares of income

Another way to look at retiree income

is to examine the total income earned

in aggregate by all older Americans

(see chart 16). Social Security again

tops the list, accounting for about 4

out of every 10 dollars of income paid

to individuals age 65 and over. Work

earnings represent nearly a quarter

of total income. Both income from

savings and retirement plans amount

to nearly a fifth each.

Income distribution

Social Security is the dominant

source of income for lower-income

households, while higher-income

households rely on multiple sources

(see chart 17 on page 24). In 2000

the bottom quintile of households,

ranked by income, earned less than

$9,000 per year; the second quintile

earned from $9,000 to $15,000.

For both groups, Social Security

accounted for 82% of their incomes.

For the middle-income group, with

income from $15,000 to $24,000 in

2000, Social Security was still a domi-

nant source of earnings, accounting

for 64% of income. But more than

one-third came from other sources—

including employer plans (16%), per-

sonal savings (9%), and work earnings

(7%). In the fourth quintile—those

older Americans earning $24,000 to

$40,000—Social Security accounted

for less than half (46%) of income.

Employer plans provided nearly

a quarter of income (23%). Personal

savings and work earnings were

also important sources of income.

The top-income segment—those

earning more than $40,000 in 2000—

was unique because of the dominance

of work earnings, which accounted

for 35% of total income. Personal

savings were the second most impor-

tant source of income (24%), with

employer plans and Social Security

making up the balance (19% each).


16. Components of Total Income in 2000P

Percentage of Total Income, Age 65 and Older, from Source

38% Social Security

23% Work earnings

18% Employer plans

18% Personal savings


3% Other

The role of Social Security

Social Security is the sole retirement

income for about one-third of older

Americans, accounting for 90% to

100% of their total income (see chart

18). In fact, for 1 in 5 recipients,

Social Security is their entire income.

Another one-third of Social Security

recipients derive the majority of their

income from Social Security; Social

Security ranges from 50% to 89% of

their income. Slightly more than a

third rely on Social Security for less

than half of their income.

The future of Social Security

In 2001 Social Security covered a

total of 153 million workers for both

old-age and disability benefits. Nearly

39 million individuals received old-

age income benefits under the pro-

gram. The average annual retirement

payment equaled about $10,100.

Social Security retirement benefits

are designed to replace about 40%

of the average American’s preretire-

ment income. This level of benefit is

about half that paid by the public

systems in continental Europe, but

on par with programs in the United

Kingdom, Canada, Australia, and

the Netherlands.

Social Security faces a well-documented

financial crisis because of demograph-

ics. The system is largely financed on

a “pay as you go” basis, meaning that

taxes on current workers are used to

pay benefits to current retirees. As the

baby boom ages, there will be a surge

in the number of Social Security

recipients, but a much smaller growth

in the number of workers paying

taxes to the system. Today there are

3.4 workers paying taxes for every

Social Security recipient; by 2030,

when the baby boom is retired, there

will be 2.1 workers for each retiree.


17. Income Distribution for Older Americans, 2000

Percentage of Income from Various Sources, by Income Quintiles

Social Security

Work Earnings

Top 20%

Fourth 20%

19% 19% 24% 35% 3%

Employer Plans

Other

Personal Savings


0% 20% 40% 60% 80% 100%

46% 23% 13% 14% 4%

Middle 20%

Second 20%

Bottom 20%

64% 16% 9% 7% 4%

82% 7% 5% 3% 3%

82% 3%3%

1% 11%

18. Role of Social Security, 2000P

Percentage of Older Americans Deriving Given Percent of Income from Social Security

100% of income: 20%

90–99% of income: 11%

50–89% of income: 33%


Less than 50% of income: 36%

The trustees of the Social Security

system estimate that the system

will be fiscally insolvent by 2041.

At that point, to restore financial

health, benefits would need to be

reduced by about 30%, or tax rates

increased by half, in order to maintain

benefits. Possible reform strategies

include combinations of benefit

reductions, tax increases, or the

greater use of prefunded investments

(whether invested centrally or

through individual private accounts).

Today Social Security accounts for

half or more of income for 6 out of

10 older Americans. Regardless of the

direction taken by reform proposals,

Social Security is likely to remain

an essential component of retirement

income for the baby boom generation.

The role of work earnings

For many Americans age 65 and older,

work earnings are a modest source of

income used to supplement Social

Security, employer plans, and personal

savings. As noted above, only 2 in 10

households age 65 and older report

that they receive work earnings.

For the baby boom generation

contemplating its retirement, work

is expected to play an increasingly

important role in financing retirement

income needs, especially if Social

Security benefits are not as generous.

One popular notion is the idea of

“phased retirement” or “bridge jobs”—

of not ending all work at retirement,

but instead moving from a primary

occupation to other type of work.

Today work earnings vary substantially

by age (see chart 19). Work earnings

are reasonably common among those

under age 75. More than 4 in 10

households between age 65 and 69

have some earnings from work,

and over a quarter of households age

70–74 do. But work earnings are

increasingly rare for households age

75 and older, presumably because of

declining health status and limits on

mobility. This data does suggest that

while “phased retirement” may help

address retirees’ needs at earlier ages,

it will likely play a reduced role for

retirees over age 75.


19. Role of Work Earnings, 2000

Percentage Receiving Income from Work Earnings, by Age

44%

4%7%

14%

26%

65–69 70–74 75–79 85+80–84


Age

0%

10%

20%

30%

40%

50%

Vanguard Defined ContributionPlans: Current Features

P A R T T W O

Defined contribution plans have become the dominant type of retirement savings plan sponsored by private sector employers in the U.S. and a critical component of the U.S. savings system.

Over the past 20 years, both

participation and savings rates

in such plans have grown.

Participants today hold high

allocations to equity investments

in pursuit of their long-term

retirement goals. DC plans in

the United States offer a com-

prehensive range of services—

including, for participants,

an array of investment choices,

financial educational materials,

and account access services.

The success of DC plans can

be measured in three key ways—

the rate at which employees

participate in their plan, the rate

at which they contribute to the

plan, and the way in which they

choose to invest their savings.

In this section we look at each

of these three metrics using data

from Vanguard’s universe of

DC recordkeeping clients.

In addition, we examine other

DC plan characteristics

using data from Vanguard

clients, including:

• Average and median

account balances.

• Investment options offered

by sponsors, and their use

by participants.

• Education and advice trends.

• Preretirement access to

savings via loans and in-

service withdrawals.

• Participant distribution

behavior when changing

jobs or retiring.

For plan sponsors and industry

providers, participation rates in DC

plans remain the most visible metric

of success. A number of factors drive

sponsor interest in participation rates:

• Employees perceive retirement

savings plans as a positive benefit,

and sponsors view savings plans as

an integral part of total compensa-

tion. Encouraging participation is

therefore a means of promoting

employee retention and loyalty.

• Under nondiscrimination testing

rules, sponsors must achieve ade-

quate participation by lower-paid

employees if higher-paid workers

are to take maximum advantage

of a 401(k) plan.

• DC plans are an ever-increasing

component of retirement wealth

for American workers. Sponsors

seek to encourage high participation

rates in an effort to promote

retirement security.

Among Vanguard DC plans with

a voluntary employee component,

the average plan participation rate

in 2001 was 76% (see chart 20).

This figure is comparable to other

industry-reported figures for average

plan participation rates.

At both the plan and participant

level, based on both Vanguard and

other industry sources, participation

rates dropped by 3% to 4% between

1999 and 2001. Although there have

been no formal studies on why rates

dropped, we suspect that it is the

result of two factors. First, the eco-

nomic slowdown in 2001 may have

caused some participants to exit

their plans because of economic wor-

ries.10 Second, strong stock market

returns in the late 1990s encouraged

workers to join their savings plans.

In the subsequent bear market, lower

stock returns may have discouraged

newly eligible workers from joining

their retirement savings plan.

Part 2 Vanguard Defined Contribution Plans—Current Features

20. Plan Participation RatesI

Unweighted Average Participation Rate

79% 76%83%80%

1999

Vanguard Profit Sharing/401(k) Council of America

2001

Source: The Vanguard Group, 2001; Greenwich Associates, 2001; Profit Sharing/401(k) Council of America, 2001a.

80% 74%

Greenwich Associates0%

20%

40%

60%

80%

100%

10 Note that participants laid off during the

economic slowdown would not have contributed to

the decline in participation rates, as laid-off workers

would be no longer eligible for plan membership

and so would be excluded from the participation

rate calculation. But currently eligible workers who

temporarily elect not to participate—because a

spouse was laid off or because of worries about

their own financial future—would contribute to

lower participation rates.

Participation Rates

Unweighted versus weighted rates

The typical way of reporting DC

plan participation is to average partici-

pation rates reported by individual

plans. In the calculation, participation

rates of all plans are given equal

weighting: A plan with 50,000 eligi-

ble employees, for example, is

assigned the same weight as a plan

with 1,000 eligible employees.

One drawback of an average plan par-

ticipation rate is its failure to capture

the effect of plan size as measured

by number of participants. Consider

two plans: Plan A with a 50% partici-

pation rate, and Plan B with a 90%

participation rate (see chart 21). The

average participation rate for the two

plans is 70%. However, Plan A has

50,000 eligible employees, while Plan

B has 1,000. If the participation rate

is weighted by the number of eligible

employees in each plan, the resulting

weighted participation rate is 51%.

Among DC plans, participation

rates vary considerably by plan size,

with larger plans having lower partici-

pation rates than smaller plans (see

chart 22). Several reasons have been

advanced to explain why participation

rates in DC plans among large

firms are lower:

• Larger companies are more

likely to offer another nonelective

DB or DC retirement plan,

and so employees in large firms

are less likely to join the voluntary

DC arrangement. In smaller

firms, where the DC plan is

often the only retirement plan

available, participation rates are

therefore higher.11

• Larger firms may find it more diffi-

cult to communicate effectively the

value of a retirement savings plan

to employees in diverse locations

and divisions.


11 Basset, Fleming, and Rodrigues, 1998.

Andrews, 1992.

21. Example of Unweighted vs. Weighted Participation Rates

Plan BPlan A Equal weighted Weighted

Eligibles

Participants

Participation rate

1,000

900

90%

—

—

70%

50,000

25,000

50%

51,000

25,900

51%

22. Participation Rates by Plan SizeI

Weighted Average Participation Rates

70%65%

69%65%

1999

1,000–4,999 All Plans

2001

Source: The Vanguard Group, 2001.

77%70%

<1,000

66%62%

5,000+0%

20%

40%

60%

80%

100%

Plan size (number of participants)

While the average plan participation

rate at Vanguard was 76% in 2001,

the weighted participation rate was

65%. One way to interpret these

different figures is that the average

employer is able to attract 3 out

of 4 eligible participants to join a

voluntary DC arrangement—i.e.,

the average plan participation rate is

76%. However, the average employee

across all plans is likely to join a

voluntary DC arrangement in 2 out

of 3 cases—i.e., the weighted plan

participation rate is 65%. The lower

weighted rate is due to the fact that

employees at larger firms are less

likely to join a voluntary DC plan.

As with the unweighted participation

rates, weighted participation rates

fell by 3% to 4% from 1999 to 2001

(see chart 23).

Participation by income and age

Participant rates also vary substan-

tially by income and age. Income

is a key determinant of participation

(see chart 24). Among low-income

employees earning less than $15,000,

about 1 in 5 (19%) employees

participate; among high-income

employees earning more than

$75,000, 9 in 10 (89%) participate.


23. Vanguard Unweighted vs. Weighted Participation Rates

Average Participation Rate

79%69%

1999

65%

76%

2001

Unweighted Weighted


0%

20%

40%

60%

80%

100%

24. Participation Rates by Income

Weighted Average Participation Rate

19%

89%80%

67% 65%

47%

<$15,000 $15,000–$30,000

$30,001–$50,000

All>$75,000$50,001–$75,000


Income

0%

20%

40%

60%

80%

100%

Age is also an important element in

the participation decision. Less than

1 in 3 employees under age 25

participate, while three-quarters of

participants between the ages of 55

and 64 join their employer’s savings

plan (see chart 25).

Defined contribution plans are

intended principally as a savings vehi-

cle for retirement. Along with plan

participation, a critical measure of

success is whether participants are

saving enough to fund an adequate

standard of living during retirement.

Vanguard participants are currently

saving an average of 7.2% of their

incomes in employer-sponsored DC

plans. The corresponding median

savings rate is 6%, meaning that half

of participants are saving above this

rate, and half below (see chart 26).

Both the average and the median

rates have fallen by a full percentage

point since 1999. As with participa-

tion rates, while no formal research

has been done on the reasons for

the decline, we believe that the eco-

nomic slowdown and poor stock

returns may have discouraged savings

behavior, particularly among newly

eligible employees.


25. Participation Rates by Age

Weighted Average Participation Rate

31%

75%

60%

75%

65%73%

60%

<25 25–34 35–44 55–64 65+ All45–54


Age

0%

20%

40%

60%

80%

100%


26. Savings Rates

8.31%

7%7.20%

6%

1999 20011999 20010%

2%

4%

6%

8%

MedianMean

Savings Rates

Distribution of savings rates

Savings rates among participants vary

widely around the average of 7.2%

and the median of 6%. One in 4

participants save between 5% and 6%

of salary. This may be due in part to

the fact that the most common

employer match is 50 cents for each

dollar contributed up to 6%. One in

10 participants saves 2% or less, while

2 in 10 participants save more than

10% of salary (see chart 27).

Demographic influences

As with participation rates, both

income and age are determinants of

savings rates. Not surprisingly, high-

income employees find it easier to

save than do low-income employees.

The most affluent save a median of

7% of income, while less affluent save

5% (see chart 28). This gap would be

greater if not for IRS dollar limits on

contributions ($11,000 in 2001); this

dollar cap effectively prevents very

high income households from saving

at higher percentage rates.

Besides income, savings rates vary

by age, with older workers not sur-

prisingly saving more than younger

workers (see chart 29).

Savings versus deferral rates

A participant’s savings rate measures the

actual contributions made by the partici-

pant in a given year divided by the

participant’s income. Calculating savings

behavior in this way provides the best

measure of actual economic savings.

Another method for calculating

savings behavior is to take an average

of participants’ deferral rates—the

rate at which participants are having

contributions deducted from their

pay. This figure is more readily calcu-

lated from recordkeeping systems

than savings rates. But the average

deferral rate is not a perfect measure

of savings behavior; in fact, it is more

reflective of anticipated or expected

rather than actual savings behavior.

Why would savings and deferral rates

differ? Participants may sign up for

a given deferral rate, but then reduce

or increase it during the year. Other

participants may be capped by IRS

dollar limits. Still others might



27. Distribution of Savings Rates

Percentage of Participants

15% 16%14%

4%

9%–10% 11%–15% >15%7%–8%

27%

5%–6%

15%

3%–4%

9%

1%–2%

Savings Rates

0%

5%

10%

15%

20%

25%

30%

28. Savings Rates by Income

Median Savings Rate

5.71%

6.93%7.00%

6.00% 6.00%

5.00%

<$15,000 $15,000–$30,000

$30,001–$50,000

All>$75,000$50,001–$75,000


Income

0.00%

2.00%

4.00%

6.00%

8.00%

receive additional income at year-end,

such as bonuses, which effectively

reduces their percentage savings rate.12

In 2001 the average Vanguard deferral

rate for participants contributing to

their plan was 8.1%, versus an average

savings rate of 7.2%. Vanguard defer-

ral rates typically run about a percent-

age point or so higher than average

savings rates.

Interestingly, for the first six months

of 2002, Vanguard average deferral

rates rose from 8.1% in 2001 to 8.3%

for the first six months of 2002. This

increase in savings behavior may

be the result of a number of factors,

such as improving economic condi-

tions or the impact of pension reform

legislation, which allows much higher

percentage-of-income contributions

to DC plans. Over time, measuring

actual savings rates as well as deferral

rates will help determine whether this

trend in savings behavior will persist.

A third factor in gauging the success

of a defined contribution plan is

whether participants are taking

appropriate levels of equity market

risk in pursuit of their long-term

goals. Despite the recent bear market

in U.S. stocks, participant equity

holdings are only marginally lower;

participants do not appear to have

significantly shifted their portfolios

away from the equity market over

the past two years.

Asset and contribution allocations

For the average plan, nearly two-

thirds of assets (63%) are invested

directly in equities (see chart 30).

This total includes both diversified

common stock funds and company

stock. If balanced and life-cycle

funds are included in the mix, 3 in 4

plan dollars (76%) are invested in

equity-linked investments, compared

with 78% in 1999.


29. Savings Rates by Age

Median Savings Rate

4.62%

6.18%

8.35%7.71%

6.00%6.00%5.84%

<25 25–34 35–44 55–64 65+ All45–54


Age

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

30. Plan Asset AllocationP

Vanguard—Defined Contribution PlansTotal equity/balanced: 76%

49% Stock funds

18% Money market/stable value

6% Bond funds

13% Balanced funds

14% Company stock


12 Average deferral and savings rates will also differ

because the two rates may be drawn from different

samples of participants.

Participant Investment Decisions

Company stock accounts for 14% of

assets for all DC plans at Vanguard.

However, among those plans actually

offering company stock, it rises to

25% of assets. These figures are some-

what below industry averages, princi-

pally because industry statistics are

dominated by very large plans with

very high concentrations of company

stock.13 (See page 78 for more infor-

mation on company stock exposure.)

Plan asset allocations vary over time

because of market performance,

changes in the ways participants are

directing their new contributions

(contribution allocation changes), and

changes in investments (exchanges).

Our data shows that participant

contribution allocations have also not

changed noticeably over the last two

years, with about two-thirds (68%) of

contributions being directed to equity

funds (both diversified stock options

and company stock), and another

13% into balanced or life-cycle

funds (see chart 31). The 2001 total

equity/balanced allocation of 81%

compares with 80% in 1999, showing

that participants have maintained

a high level of exposure to equities.

Equity allocations

About half of Vanguard participants

invest more than 80% of their assets

in equities (see chart 32), defined here

as diversified common stock funds,

company stock, and 60% of the bal-

ance held in balanced and life-cycle

funds. An additional third invests

between 20% and 80%, and only 12%

of participants do not invest in equity

funds at all.


31. Participant Contribution AllocationP

Vanguard—Defined Contribution PlansTotal equity/balanced: 81%

58% Stock funds

14% Money market/stable value

5% Bond funds13% Balanced funds

10% Company stock


32. Equity Allocation


12.3% 13.3%

21.3%

16.3%

27.2%

5.1%4.4%

0 1%–20% 21%–40% 61%–80% 81%–99% 100%41%–60%


Percentage of account assets in equities

0%

5%

10%

15%

20%

25%

30%

13 See Mitchell and Utkus, 2002, for details on

company stock holdings in DC plans.

The percentage of participants with

more than 80% of their account in

equities has declined over the past

two years, from about 60% to less

than 50% of participants, in line with

the decline in the U.S. equity mar-

kets. Overall this appears to be the

result of two effects: falling stock

market values and modest shifts by

some participants out of equities and

into fixed income investments.

Total equity holdings remain fairly

constant across plan size (see

chart 33). However, among larger

plans there is a substitution of com-

pany stock holdings for diversified

equity funds. Large plans are much

more likely to offer company stock,

and when they do are also more

likely to restrict participants’

ability to diversify out of that stock.

(See page 78 for more information

on company stock exposure.)


Participant income and age are key

factors influencing investment deci-

sions. Higher-income participants

take on somewhat more equity

market risk, while lower-income par-

ticipants do not. However, at least

among Vanguard clients, the differ-

ence in equity exposure by income

level is not dramatically different. In

2001 participants earning more than

$75,000 had an average of 73% of

assets invested in equities, while par-

ticipants earning less than $15,000

had 64% of account assets in equities

(see chart 34).


33. Asset Allocation by Plan Size

StockFunds

CompanyStock

BalancedFunds

TotalEquity

BondFunds

Number of participants

Money Market/Stable Value

<1,000

1,000–4,999

5,000+

All Plans

17%

20%

18%

18%

7%

5%

6%

6%

70%

68%

72%

71%

18%

15%

11%

13%

1%

7%

19%

14%

58%

52%

46%

49%

*Stock, company stock, and 60% of balanced funds. Source: The Vanguard Group, 2001.

Asset Allocation

*

34. Asset Allocation by Income

StockFunds

CompanyStock

BalancedFunds

TotalEquity

BondFunds

Income


<$15,000

$15,000–$30,000

$30,001–$50,000

$50,001–$75,000

>$75,000

All (mean)

24%

25%

22%

19%

16%

18%

6%

6%

6%

5%

5%

6%

64%

63%

66%

70%

73%

71%

14%

14%

14%

14%

12%

13%

15%

13%

13%

14%

15%

14%

41%

42%

45%

48%

51%

49%


Asset Allocation

*

Younger participants generally take

on more equity market exposure than

older participants (see chart 35).

(The data for participants under age

25 is an anomaly undoubtedly due to

a very small sample size.) As a whole,

participants appear to have taken the

“time diversification” principle to

heart—namely, the longer your time

horizon, the higher your commitment

to equities.

It remains a topic of debate as to how

older participants end up with more

conservative allocations. One explana-

tion is that, as they age, participants

gradually shift monies from equities

to fixed income. This is a common

financial education principle.

A second theory is the so-called

“demographic cohort” effect.

Participants of a given age belong to

a generational cohort, and that cohort

develops similar investment risk

preferences based on its shared life

experiences. In other words, younger

investors may hold more in equities

because of common generational per-

ceptions—e.g., greater awareness of

the returns of equities, the influence

of the bull market, greater acceptance

of risk-taking. Although research has

not resolved the debate between the

two theories, it’s likely that both fac-

tors—the lower risk tolerance of older

investors and common demographic

cohort experiences—play a role.


35. Asset Allocation by Age

StockFunds

CompanyStock

BalancedFunds

TotalEquity

BondFunds

Age


<25

25–34

35–44

45–54

55–64

65+

All (mean)

21%

10%

12%

17%

24%

34%

18%

6%

4%

5%

6%

7%

9%

6%

64%

80%

79%

72%

64%

51%

71%

23%

12%

13%

13%

13%

13%

13%

9%

13%

15%

15%

13%

9%

14%

41%

60%

56%

49%

43%

34%

49%


Asset Allocation

*

Defined contribution plan account

balances are important on two counts:

• Retirement savings adequacy.

Account balances measure how

much workers have accumulated

for retirement at their current

employer, and thus influence

an important policy question—

Are workers saving enough

for retirement?

• Economics of retirement providers.

Average balances are also of interest

to retirement services providers

and sponsors negotiating plan fees.

Most revenues for providers are

typically generated through asset-

based fees. The economics of

the retirement services business

is therefore directly linked to

average balances.

On both of these questions, current

DC plan balances only tell part

of the story. In the United States,

DC plans are not a closed system;

when employees change jobs or retire,

monies are frequently rolled over to

IRAs.14 As a result, because of job

changes, participants’ current balances

do not reflect lifetime DC savings.

Job changes are reasonably com-

mon—among Vanguard recordkeep-

ing participants, median plan tenure

is six years and median employment

tenure is ten years.

A complete analysis of retirement

savings adequacy must reflect not only

current DC plan balances, but also

Social Security, DB programs, IRAs,

and other assets held by workers.

(See page 73 for a discussion of retire-

ment savings adequacy.) Similarly, the

economics of DC service providers

depend not only on current DB plan

balances, but also on potential IRA

rollover assets arising when partici-

pants change jobs or retire.

Mean versus median balance amounts

Among Vanguard recordkeeping par-

ticipants, the average account balance

in 2001 totaled about $48,000 (see

chart 36). The median balance was

about $15,000, roughly one-third

of the average balance.


36. Account Balances

Account Balance

$14,676

$47,980

$15,360

$48,299

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000


1999 20011999 2001

MedianMean

14 Nearly half of all IRA holders report that their

accounts include monies from employer retirement

plans. See ICI, 2002, p. 48.

Account Balances

During the recent decline in stock

prices, the average account holder

saw balances fall, as new contributions

were not adequate to offset market

losses on existing investments. The

median account holder, with a balance

of just more than $15,000, saw account

values rise as investment losses were

offset by new contributions.

These figures underscore the impor-

tance of differentiating between

the experiences of the average versus

the median participant in understand-

ing the impact of market volatility.

The wide divergence between the

median and the average balance is

due to a small number of very large

accounts, which significantly raise

the average (see chart 37). Mean-

while, more than 4 in 10 participants

have $10,000 or less in their

DC plan accounts.


37. Distribution of Account BalancesA


<$10,000 $10,000–$20,000

$20,001–$40,000

$40,001–$60,000

$60,001–$80,000

$80,001–$100,000

>$100,000

2001

Account balances

1999


0%

10%

20%

30%

40%

50%

42% 41%

14% 15% 14% 15%

8% 8%5% 5% 3% 3%

13%13%


Among the factors influencing account

balances are participant income, age,

and plan tenure. These three factors

are intertwined. Not only do incomes

rise somewhat with age, making

saving more affordable—but older

participants generally save more as

they move closer to retirement. Also,

workers with long tenure in a plan

will contribute to higher balances

for a number of reasons. The longer

workers stay at their jobs, the more

likely they are to participate and save

in a retirement savings plan. Also,

their balances in their current plan

will be higher because they have

not recently changed jobs.

Higher account balances follow higher

incomes (see chart 38), with a signifi-

cant increase at the affluent end of

the scale. Balances for participants

earning more than $75,000 are almost

double those of participants earning

between $50,000 and $75,000.

Median balances follow a more

linear pattern, moving from just

less than $7,000 for low-income

participants to more than $31,000

for high-income participants.

Account balances also rise with

participants’ ages (see chart 39)

in a consistent manner.


38. Account Balance by Income

Account Balance

$27,241

$6,626

$46,611

$18,727

$47,980

$15,360

$80,193

$31,733$34,379

$12,605

$26,496

$8,225

<$15,000 $15,000–$30,000

$30,001–$50,000

>$75,000 All$50,001-$75,000

Income

$0

$20,000

$40,000

$60,000

$80,000

$100,000

Mean Median


39. Account Balance by Age

Account Balance

$2,74

5$1

,393 $1

2,178

$5,9

78

$35,

514

$15,

812

$63,

695

$25,

940

$93,

571

$37,3

43

$117

,643

$41,9

11

$47,9

80$1

5,36

0

<25 25–34 35–44 45–54 55–64 65+ All

Median

Age

Mean


$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

Finally, participants with higher

balances are also more likely to be

longer-tenured employees, having

seen both their income and their

balances grow over time (see

chart 40).

Plan sponsors have continued to

increase the number and type of

investment options available to

participants in an effort to encourage

diversified investment holdings.

However, participant usage of these

options, both in the number of funds

held and the type of investment

options chosen, has not kept pace.

Type of options offered

Virtually all Vanguard DC plans

offer a balanced array of investment

options covering four major invest-

ment categories: equities, bond

funds, balanced funds, and money

market/stable value options (see

chart 41 at right). Given the desire

of most sponsors to encourage partici-

pant holdings of equities for their

retirement goals, diversified equity

funds continue to be the most popular

type of funds offered. Equity offer-

ings typically include both indexed

and active U.S. stock funds, including

both large-capitalization and mid-

or small-capitalization stocks, as

well as one or more international

fund options.


40. Average Account Balance by Tenure

Average Account Balance

$6,0

31$6

,446

$9,6

85$9

,219

$16,

972

$15,

687 $3

3,21

3$2

9,26

7

$57,6

99$5

6,76

8

$97,2

03$1

01,7

59

$48,

299

$47,9

80

<1 1–3 4–5 6–10 11–15 >15 All

2001 Mean

Tenure in years

1999 Mean


$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

Plan Investment Options and Decisions

Fifteen percent of plans offer company

stock as an investment choice.

(See page 78 for more information

on company stock holdings.)

Meanwhile, sponsor interest in bond

index and life-cycle funds has

increased by more than 12% each

over the last two years.

Interest in self-directed brokerage

accounts and mutual fund windows

has more than doubled over the past

two years, though the level of usage

remains low, with 7% of Vanguard

plans utilizing brokerage accounts or

windows. Self-directed brokerage

accounts allow participants to choose

investments from literally thousands

of individual stocks, bonds, and

mutual funds. Mutual fund windows

provide participants with access to

a large menu of mutual funds.


41. Type of Investment Options Offered

Vanguard Percentage of Plans Offering

Equity fundsActive domestic

Index domestic

Company stock

International

Balanced fundsTraditional balanced

Life-cycle options

Bond fundsActive

Index

Stable value/investment contract

Money market

Self-directed brokerage/ mutual fund window

Profit Sharing/401(k) Council of America

97%

95%

15%

90%

81%

40%

47%

73%

43%

75%

7%

77%

54%

21%

64%

61%

26%

60%

21%

32%

72%

14%

Source: The Vanguard Group, 2001; Profit Sharing/401(k) Council of America, 2001a.

Number of options offered

Sponsors continue to expand the

number of investment options offered

in DC plans, typically in response

to a small group of participants

seeking greater investment flexibility.

Today the average Vanguard plan

offers 14 investment options, up

from 12 options two years ago (see

chart 42). Sixty percent of plans

offer between 8 and 15 options,

while about 1 in 4 plans (22%) offer

more than 15 investment choices

to their participants.

With the U.S. bear market of the past

two years, surveys indicate that plan

sponsor interest in expanded choice

may be waning. As one example, Ford

Motor Company recently announced

that it was streamlining the investment

menu in its 401(k) plan, reducing

the number of options offered from

60 to 36. Among the concerns associ-

ated with increased investment choice

are the possibility for greater partici-

pant confusion; the need for addition-

al investment communications and

education; the worry that demand for

choice was driven more by short-term

market performance (e.g., the surge

in growth funds in the late 1990s);

and finally, the recognition that most

participants do not opt for additional

investment choices when they are

made available.

Number of options used

Participant use of investment options

has remained unchanged over the past

two years, despite an increase in the

number of options offered. The aver-

age participant holds 3 options, the

same number as in 1999, even as the

number of options offered grew

from 12 to 14. About half (44%) of

participants invest in only 1 or 2

options (see chart 43); nearly 9 in 10

hold 5 options or less. Only 13%

diversify their holdings with 6 or

more options.


42. Number of Options Offered

Percentage of Plans Offering

4.3%

30.6%

22.0%

31.8%

11.3%

1–4 5–7 8–10 16+

Mean number of options =14

11–15

Number of options

0%

5%

10%

15%

20%

25%

30%

35%


43. Number of Options Used


23.8% 24.7%

12.9%

18.6%20.0%

1 2 3 6+4–5

Number of options

0%0%

5%5%

10%10%

15%15%

20%20%

25%25%

Mean number of options used = 3


Life-cycle funds in plans

Life-cycle funds are balanced portfo-

lios with varying risk/reward charac-

teristics. Plan sponsors offer these

funds to provide one-stop investment

decision-making to novice investors.

Forty percent of plans offer one or

more life-cycle funds, up from 28%

two years ago, and they account

for about 8% of average plan assets.

Participant usage has increased by

a small amount. Twenty-two percent

of participants offered a life-cycle

option select it, a 2% increase over

1999 (see chart 44). Of plans offering

life-cycle options, two-thirds have less

than 10% of their total assets invested

in them (see chart 45), showing no

change from two years ago.


44. Plan Use of Life-cycle OptionsAverage Recordkeeping Assets

Percentage of plans offering

Percentage of plan assets invested*

39.7%

7.7%

22.0%

39.2%

Percentage of participants using*

Percentage of participant account balances

0% 10% 20% 30% 40%

*In plans offering life-cycle options. Source: The Vanguard Group, 2001.

45. Life-cycle Use Across PlansW

Percentage of Plans

16%

6%9%

19%

50%

<5% 10%–14% 15%–19% >20%5%–9%


Percentage of plan assets in life-cycle options

0%

10%

20%

30%

40%

50%

60%

Participant use of life-cycle funds

Life-cycle funds are principally

designed as an investment choice for

novice investors—the “one-stop

shopping” choice offering complete

portfolio diversification in a single

fund. Among Vanguard participants,

just more than one-quarter (27%) use

them as such, investing their entire

account balances in a single life-cycle

fund (see chart 46).

Many participants appear to use life-

cycle funds as part of a more broadly

diversified portfolio, not as an all-in-

one investment choice. A majority

(55%) of life-cycle investors hold one

life-cycle fund plus one or more other

investment options offered by their

employer’s plan. Most of these

participants add one or more stock

funds to their life-cycle holdings—

suggesting that they view life-cycle

funds as another low-risk equity-

oriented option. A group of these

participants (14% of total) owns

company stock along with the life-

cycle option, which may reflect either

mandatory employer matching

contributions in stock or employee

discretionary contributions.

Finally, just less than 1 in 5 partici-

pants (18%) own more than one life-

cycle fund, sometimes with other

investment options. These partici-

pants clearly seem to be overdiversi-

fied, especially given the “one-stop

shopping” design of life-cycle funds.

These investment patterns carry over

to asset holdings of life-cycle funds.

Twenty-nine percent of life-cycle

investors have 100% of their account

balance in (one or more) life-cycle

funds (see chart 47). At the other

extreme, just under one-third of life-

cycle investors (32%) have less than

a quarter of their account balance

invested in life-cycle options.


46. Number of Life-cycle and Other Funds HeldP

27.0% One life-cycle fund only

18.2% Two or more life-cycle funds plus other funds

54.7% One life-cycle fund plus other funds


47. Account Balance in Life-cycle Funds


31.9%29.3%

7.9%9.7%

21.1%

1%–24% 25%–49% 50%–74% 100%75%–99%


Percentage of assets in life-cycle funds

0%

5%

10%

15%

20%

25%

30%

35%

Company stock

Company stock is typically offered

as an investment option by larger DC

plans (see page 78). Company stock

holdings may arise through voluntary

employee contributions or through

employer contributions, which may be

in the form of 401(k) matching, profit-

sharing, or ESOP contributions.

As of 2001, only 15% of Vanguard

recordkeeping plans offered company

stock as an investment option.

However, because large plans are

more likely to offer company stock,

53% of Vanguard recordkeeping par-

ticipants had access to company stock,

and 31% held actual investments

in company stock.

Among Vanguard plans offering com-

pany stock, two-thirds had 20% or

less of plan assets invested in compa-

ny stock (see chart 48). The remain-

ing third had concentration levels of

more than 20%. The plans with the

higher levels of concentration tend to

be larger plans. Large plans are more

likely to offer employer matching or

other contributions in the form of

company stock; they are also more

likely to impose restrictions on diver-

sification of employer contributions

(see page 79).

Of the Vanguard participants with

access to company stock through their

plans, about 40% have no holdings in

company stock (see chart 49). These

are participants who have chosen not

to invest their own contributions in

company stock; also, they either have

no employer matching contributions

in stock, or are able to diversify

those contributions.

Another one-fifth or so of partici-

pants have up to 20% of their

account balance invested in company

stock. Just over 1 in 3 (36%) of

Vanguard participants have concen-

trated positions exceeding 20%

of account balances.


48. Company Stock Exposure for Plans

Percentage of Plans

67%

5%2%

7%

19%

1%–20% 21%–40% 41%–60% >80%61%–80%


Balance of plan in company stock (%)

0%

10%

20%

30%

40%

50%

60%

70%

80%

49. Company Stock Exposure for Participants


41%

5%8%

13%10%

22%

0% 1%–20% 21%–40% >80%61%–80%41%–60%


0%

10%

20%

30%

40%

50%

Balance in company stock (%)

International funds

Although most plans offer interna-

tional funds, interest among partici-

pants is relatively low. Today less

than 20% of participants select the

option. When they do so, they invest

modestly, directing only 12% of their

assets to these funds (see chart 50).

The decline in exposure is likely

due to lower relative returns on

foreign stocks as well as a possible

decline in usage.


50. Use of International OptionsAverage Recordkeeping Assets

Percentage of plans offering

Percentage of plan assets invested*

11.8%

19.0%

2.8%

90.2%

Percentage of participants using*

Percentage of participant account balances

*In plans offering international options. Source: The Vanguard Group, 2001.

0% 20% 40% 60% 80% 100%

Exchange activity represents another

measure of participants’ investment

decision-making. Unlike a change in

their contribution allocation, where

participants decide to redirect future

contributions to the plan to other

investments, an exchange involves

moving currently invested monies

from one plan investment option to

another. Exchanges are a proxy for

participants’ holding period for

investments, as well as a measure of

their patience in pursuing long-term

financial goals.

This section summarizes data on

exchange activity for 2001. A longer-

term look at the trading behavior of

participants can be found on page 89.

Exchange provisions

Daily exchanges are nearly universal

for Vanguard DC plans, with almost

96% of plan sponsors allowing

them (see chart 51). Daily exchange

capabilities are made possible by the

daily valuation of investment assets,

which all Vanguard clients offer

and which is the norm in the record-

keeping industry.

Volume of exchanges

Exchange activity is associated with

only a small number of participants,

however. In 2001, 14% of Vanguard

participants exchanged money from

one investment option to another,

down from 17% in 1999. The majority

of participants made no investment

exchanges. Whether this is due to a

commitment to long-term investment

strategies, indecision in the face of the

bear market in U.S. stocks, or simple

inertia, most participants seem

inclined to make an investment deci-

sion and then stay put.

That said, participants who make an

exchange do move a large volume of

money. In 2001 the 14% of partici-

pants making exchanges moved 23%

of all DC recordkeeping assets at

Vanguard (see chart 52).


51. Exchange Provisions

Percentage of Plans

Less than quarterly

Frequency of exchanges permitted

Quarterly

0.3%

2.4%

1.6%

95.7%

Monthly

Daily


0% 20% 40% 60% 80% 100%

52. Vanguard 2001 Exchange Activity

Total Participants

Participants making exchanges

$118 billion

2.3 million

Participants not making exchanges


Average Recordkeeping Assets

0% 20% 40% 60% 80% 100%

0% 20% 40% 60% 80% 100%

77%23%

14% 86%

Exchange Activity

The volume of assets moved declined

from two years ago, when participants

moved nearly a third (32%) of all

assets. Over short periods, the volume

of exchange activity appears to be

related to stock market activity—

exchange levels peaked in March

2000, at the recent peak of the U.S.

equity market. Over long periods,

though, there appears to be no firm

statistical link between trading activi-

ty and stock market levels.

This data on trading activity suggests

that there are two participant popula-

tions within DC retirement plans.

One population has a very long

time horizon and undertakes little

or no exchange activity; another has

a short time horizon, possibly a

year or less, with frequent levels

of money movement.

Concentration of exchange activity

Among participants making investment

exchanges, exchange activity is itself

highly concentrated. Not only is a small

group of participants responsible for

overall money movement, exchange

activity is further concentrated in a few

“hot hands” (see chart 53). One-fifth

of 1% of participants moved 9% of

all Vanguard DC assets in 2001. An

additional 1% of participants moved

another 5% of assets.

The number of “frequent traders” has

remained relatively unchanged, but

the volume of assets being moved is

lower. In 2001 slightly more than 1%

of participants moved 14% of

Vanguard recordkeeping assets; in

1999 the same percentage moved 19%

of assets. During this period, a num-

ber of Vanguard plan sponsors imple-

mented rules designed to discourage

day trading in retirement plans.

Meanwhile, stock market levels

declined during the period.

Direction of money movement

As equity market conditions have

deteriorated over the past two years,

participants making investment

changes have shifted their portfolios

somewhat to fixed income invest-

ments, particularly in 2001. In 1999,

during a very positive period for U.S.

equities, approximately 1% of

Vanguard recordkeeping assets was

shifted out of equities into fixed

income investments. In 2000, espe-

cially in the first quarter of the year

as U.S. equity prices peaked, there

was a strong net flow into common

stocks, again about 1% of assets.

In 2001, as equity market conditions

continued to remain weak, partici-

pants shifted a net of 2.5% of record-

keeping assets from equities to

fixed income investments. The aggre-

gate change in asset allocations from

1999 to 2001 was less than this

amount, however, as exchange

behavior out of equities was offset by

new contributions.

See page 90 for more information

on trading activity and net

money movement.


53. Concentration of Exchange Activity

Percentage of Total Participants

Percentage of AverageRecordkeeping Assets

0.2%

1.0%

2.7%

9.8%

9%

5%

4%

5%


Retirement savings communications

and education are essential to a suc-

cessful participant-directed defined

contribution plan. Through work-

place financial education, employees

learn why they should participate in

an employer retirement plan, how

they should invest, and how much

they’ll need to save to achieve their

financial goals.

Overall effectiveness

Education has a measurable and dra-

matic impact on participant behavior,

according to several academic and

industry studies. It is particularly

effective in boosting participation

and savings rates. Simply making

education available in the work-

place raises participation rates by

11.8% in absolute terms (see

chart 54). And when participants

actively engage in workplace educa-

tion programs, participation rates

rise 19.5%.

Education’s impact appears to be

strongest among low-balance partici-

pants. High-balance participants

already participate at a higher rate and

save more; the marginal impact of

education is therefore muted. High-

balance participants are also constrained

by IRS limits on their contributions,

and so are restricted in their ability to

change their savings behavior in

response to workplace education.

Besides increasing participation, edu-

cation also boosts savings rates (see

chart 55). With workplace education,

participants save more for retirement

and have higher retirement plan bal-

ances. They also have higher total

household savings rates. In essence,

through a spillover effect, workplace

education prompts participants to

take a comprehensive look at all of

their personal finances. This spillover

even affects spouses of nonhighly

compensated employees. Spouses of

participants with access to workplace

education have higher participation

and savings rates in their own

employer’s plan.15


0%

5%

10%

15%

20%

54. The Impact of Education on Participation

Increase in Participation Rate

11.8%

19.5%

Education available in workplace Education used by participants

Source: Bernheim and Garrett, 1996.

15 Bernheim and Garrett, 1996.

55. The Impact of Education on SavingsIncrease in Participation Rate

3.0%3.9%

6.0%

7.7%

$5,000

$7,508

No education

Retirement savings rate

Total household savings rate

Plan balances

With education

Source: Bernheim and Garrett, 1996.

0%

2%

4%

6%

8%

10%

$0

$2,000

$4,000

$6,000

$8,000

$10,000

Participant Education and Advice

The effectiveness of employee meetings

Group employee meetings are a par-

ticularly powerful medium for

employee education (see chart 56).

Even after accounting for differences

in plan features and other educational

offerings, group meetings were shown

to increase participation rates 12.1%

in absolute terms. Meetings also

boosted savings rates 1.1%—a gain

of 37% over the average savings rate

of 3% for nonhighly compensated

employees in this study.

Meetings are most effective among

nonhighly compensated employees.

For the highly compensated, the

impact of meetings, as with education

generally, is muted because of already

high participation and contribution

rates and IRS limits on contributions.

Employee “money attitudes”

Participants have different psycholog-

ical characteristics when it comes to

planning for their future and manag-

ing their retirement savings. They can

be classified into five segments rang-

ing from Successful Planners, who

have a strong interest in retirement

planning and in equity risk-taking,

to Live-For-Today Avoiders, who are

focused on current financial needs

and are uninterested in thinking

about the future. Each of these seg-

ments has different demands for

education, advice, and assistance,

and will react differently to the types

of communications offered and

messages delivered.

For more information on money

attitude segmentation and its role

in education programs, see page 83.


0%

3%

6%

9%

12%

15%

56. The Effect of Employee Meetings

Percentage Increase

12.1%

Increase in participation rates Increase in contribution rates

1.1%

Note: Nonhighly compensated employees only.

Source: Bayer, Bernheim, and Scholz, 1996.

Participant demand for education

There is a strong interest in, and

demand for, investment and retire-

ment education among participants.

Participants are most interested in

retirement planning, with more than

9 in 10 expressing a desire for addi-

tional education in this area (see

chart 57). Nearly 9 in 10 want more

details on company plan provisions.

Many are interested in advanced

investing or financial planning topics.

Advice is one of the most popular

education subjects. Eighty-nine

percent of participants are very or

somewhat interested in receiving rec-

ommendations on plan investments

(see chart 58).

Most participants also are seeking

additional “beyond the plan” financial

information on topics such as

IRAs, taxable investments, brokerage

accounts, and variable annuities,

up significantly from 1999.


57. Participant Education NeedsAverage Recordkeeping Assets

Very interested

Company plan details

Retirement planning

Personal financial information

Advanced investment information

Somewhat interested Not at all interested


0% 20% 40% 60% 80% 100%

28% 9%

37% 11%

29% 33%

43% 19%

63%

50%

36%

36%

58. Participant Additional InterestsAverage Recordkeeping Assets

Very interested

Advice

IRAs

Taxable investment accounts

Brokerage accounts

Variable annuities

Somewhat interested Not at all interested


0% 20% 40% 60% 80% 100%

6%80%

82%

66%

18% 14%68%

15% 11%74%

14%

6%12%

23% 11%

Within defined contribution plans, a

variety of account access services have

evolved to foster participant control

over plan savings and facilitate invest-

ment decisions. Yet despite the avail-

ability of phone, voice-response, and

Web-access channels, most partici-

pants have very little or no interaction

with their plan savings in a given year.

A minority of participants is actively

engaged in managing their accounts.

For this group, improved technology

and near-universal Internet access

have dramatically accelerated the use

of the Web as an access method.

Frequency of account access

In 2001 nearly half of plan partici-

pants never contacted Vanguard

regarding their plan investments

(see chart 59), a level unchanged

from 1999. For these participants,

quarterly investment statements,

mailed automatically, were the

sole method for reviewing plan bal-

ances and investments.

Three in 10 participants are infre-

quent contactors. They contact

Vanguard an average of 4 times per

year, whether through a telephone

associate, an interaction with a voice-

response unit, or via the Internet.

Almost a quarter of participants are

frequent contactors. They contact

Vanguard through all channels an

average of 38 times per year, an

average of more than 3 times per

month. (Although this level of con-

tact may seem quite high, keep in

mind that with the Internet, a

brief look at fund prices or account

balances constitutes a distinct and

separate contact.)

Contact behavior is influenced

primarily by account balances

(see chart 60). The larger a partici-

pant’s balance, the more likely the

participant will be proactive about

obtaining information from

Vanguard. The balance for frequent

contactors is nearly two-and-a-

half times as high as the balance

for noncontactors.


59. Account Access FrequencyP

47.8% Noncontactors

22.4% Frequent contactors

29.8% Infrequent contactors


60. Demographics of Contactors

Balance Age Years

In Plan Married Male Income

>$75,000

Noncontactors

Infrequent contactors

Frequent contactors

All participants

36.2%

36.3%

45.3%

38.2%

61.3%

62.3%

74.7%

64.6%

70.4%

79.8%

77.4%

72.1%

7.2

7.6

9.0

7.7

43.6

43.3

44.7

43.6

$43,534

$59,903

$105,213

$62,211


PercentageMean

Access Methods and the Internet

Frequent contactors share a number

of similar demographic characteris-

tics. Compared with the general par-

ticipant population, they are more

likely to be high-income, high-bal-

ance, male participants. Based on

recordkeeping data, this finding is

similar to results from a Vanguard

national survey of plan participants, in

which affluent, educated male partici-

pants, typically in professional or

executive positions, were more likely

than others to actively track the stock

market and transact in their retire-

ment accounts.16

Types of account access

Participants rely on three channels

for access to their accounts: toll-free

telephone calls to service associates,

automated voice-response systems,

and the Internet. When measured

in terms of total participant usage

per channel, telephone contact with

a service associate remains the most

widely used. During 2001, 4 in 10

participants who contacted Vanguard

about their employer’s plan used a

service associate (see chart 61).

Automated voice-response systems

were second in popularity, the

Web third.

But when measured in terms of num-

ber of total contacts, the Internet

predominates. Web interactions

accounted for 40% of all participant

contacts, with an average of 27

web interactions per year.

Internet access and usage

Most Vanguard DC plan participants

now have access to the Internet,

either at home or at work. In 2001,

85% reported having access to the

Internet either through home,

work, or both (see chart 62). This

is an increase over 1999, when

3 in 10 participants reported no

access to the Internet. Of those with

Internet access, 20% report visiting

Vanguard.com® for plan-related finan-

cial information at least once a week.


61. Account Access MethodsIncrease in Participation Rate

42%

25%14% 13%

40%47%

17.7

2.9

27.4

Telephone associate

Percentage ofparticipants using

Percentage ofcontacts

Mean numberof contacts

InternetVoice-response unit


0%

20%

40%

60%

80%

100%

0

5

10

15

20

25

30

16 See Vanguard, 2002a.

62. Participant Access to the InternetP

50% Both at home and at work

11% At work


24% At home

15% Do not have access

Participants use the Internet

principally to obtain investment

information on their retirement plan

accounts. Among Vanguard partici-

pants, two-thirds of webpage hits

are devoted to obtaining investment

information (see chart 63). That

information includes: market sum-

maries; information on investment

choices available in the participants’

retirement plan; investment perfor-

mance; and fund prospectuses

or reports.

The Internet is also used for checking

account balances. More than 30%

of the page hits to the Vanguard

participant website are for account

balance information.

The Vanguard participant website

also features education content and

advisory services, plus plan transac-

tion services such as payroll salary

deductions, contribution investment

allocations, or loans. Average daily

page hits for these capabilities repre-

sents only 2% of total page hits. This

might suggest that these capabilities

are considerably less valuable to par-

ticipants. Or it may reflect the ease of

checking investment performance and

account balances on the Web. With

Web-savvy participants reviewing

investment information and account

balances at very high rates, it is not

surprising to find that more complex

and time-consuming issues, such as

reviewing education content or

undertaking a transaction, would

account for much lower volumes

of web activity.


63. Major Activities on Vanguard.comP

31.7% Account balance

1.6% Planning and advice


66.1% Investment information

0.6% Transactions

Plan loans allow 401(k) participants

to access their plan savings before

retirement, without incurring income

taxes or tax penalties. Because they

provide financial flexibility during

the working years, loans are thought

to be effective in encouraging younger

employees to participate in their

employer’s plan. Yet they are not

without risks. Monies that have been

borrowed earn fixed income, rather

than equity market returns. Partici-

pants who leave their employer also

must typically repay any loan balance

immediately, or risk paying taxes

and a penalty.

Loan availability

Plan loans are offered widely among

401(k) plans (see chart 64). About 8

in 10 Vanguard 401(k) plans offer

a loan provision.

The availability of loans depends on

plan size. Large plans tend to offer

loans, small plans often do not.

Among large plans (those with more

than 10,000 participants), 88% offer

loans, while among small plans

(those with 100 or fewer partici-

pants), 54% do.17

Loans are very expensive to administer,

and loan origination and maintenance

fees are increasing in prevalence.

With loan fees, sponsors can allocate

costs directly to the participants

incurring loan-related expenses. Loan

fees also may serve as a disincentive

to participants to use the loan feature

as a revolving line of credit.

Types of loans offered

Most plans with loans allow partici-

pants to borrow for general purposes

or for a principal residence (see

chart 65). Loans for education or

medical expenses are compara-

tively rare.


64. 401(k) Plans Offering LoansA

Percentage of 401(k) Plans

Vanguard

Profit Sharing/401(k) Council of America

76%

86%

58%

EBRI/ICI

Source: The Vanguard Group, 2001; EBRI/ICI, 2001a; Profit Sharing/401(k) Council of America, 2001a.

0% 20% 40% 60% 80% 100%

65. Types of Loans OfferedA

Percentage of 401(k) Plans

General purpose

Principal residence

99%

88%

3%

1%

Education

Medical


0% 20% 40% 60% 80% 100%

17 EBRI/ICI, 2001a.

Plan Loans

Loan exposure and loan use

Fewer than 1 in 5 participants takes

a loan (see chart 66). On average,

participants taking a loan borrow

14% of their account balance. The

average loan amount in 2001 was

about $6,800, down somewhat from

$7,200 in 1999.

Loans are sometimes criticized as a

form of revolving credit for younger,

lower-income workers. While that

may be partly true, loan use is actually

more prevalent among workers in

their 30s and 40s—about 50% higher

than for workers in their 20s. For

example, 16% of Vanguard partici-

pants in their 40s have loans, while

only 8% of participants in their 20s

do (see chart 67).


66. Loan Usage


Average loan amount

Percentage of participantswith loans

Percentage of participantbalances borrowed

$6,856

17%

14%


$0 $2,000 $4,000 $6,000 $8,000 $10,000

Loan Amount

0% 5% 10% 15% 20%

67. Loan Usage by Age

Percentage of Participants With Loans

8%

15% 14%

20s 30s Average

16%

40s

13%

50s

7%

60s

Age


0%

5%

10%

15%

20%

25%

While loan use is highest among par-

ticipants in their 30s and 40s, the

greatest financial exposure to loans—

expressed as a percentage of total

assets—is among participants in their

20s (see chart 68). These participants

average 27% of their account balance

as a loan, almost double the overall

percentage for all loan users.

This stands to reason, as participants

in their 20s typically have smaller bal-

ances. As a result, when they take a

loan, they are likely to have higher

loan exposure as a percentage of total

assets. But it also means that when

young participants change jobs,

which they are more likely to do, they

face a greater financial risk in either

repaying the loan immediately, or

incurring taxes and penalties on the

outstanding balance.

Demographics of loan users

How do loan users, accounting for

less than 1 in 5 participants, compare

with the other 4 in 5 participants who

do not take loans? Among Vanguard

participants, loan users and nonloan

users are the same age (43 years old

on average) and have virtually identi-

cal account balances (see chart 69).

Income is where they differ. Across

the board, loan users are more likely

to have lower incomes. In particular,

there are more loan users with

incomes under $75,000. Not surpris-

ingly, high-income households, those

with incomes above $75,000, are

less likely to use loans.


68. Loan Exposure by Age

Percentage of Account Balance in Loan

27%

21%

14%

20s 30s Average

15%

40s

11%

50s

9%

60s

Age


0%

5%

10%

15%

20%

25%

30%

69. Demographics of Loan Users

Participants With Loans

Average Age

Average Account BalanceIncome Range<$15,000

$15,000–30,000

$30,001–50,000

$50,001–75,000

>$75,000

ParticipantsWithout Loans

43

$48,016

4.0%

10.2%

24.5%

29.8%

31.5%

43

$47,433

3.4%

8.8%

20.9%

27.0%

39.9%


Multiple loans

Although 6 in 10 Vanguard 401(k)

plans allow only one loan per

participant, a number of plans allow

participants to have multiple out-

standing loans. Twenty-eight percent

of plans allow two loans, and

10% allow three or more loans (see

chart 70).

Offering additional loans does not

appear to affect the usage of loans.

The percentage of participants taking

loans ranges from 16% to 18% of

plan participants, whether one, two,

or three or more loans are offered.

The actual exposure to loans as a

percentage of account balances is also

basically unchanged—varying from

14% to 15% of account balances

(see chart 71).

What does vary are participants’

average balances and the value of the

loans they have taken. Plans that

offer more loans have the same usage

rate of loans, but they also have

higher average balances and higher

loan values outstanding. As a result,

the percentage exposure to loans is

similar to plans with only one loan.

Overall, plans that offer multiple

loans are plans with above-average

balances. These above-average bal-

ances may arise for several reasons—

the plan has been in existence for a

long time, the participants are long-

tenured employees, or the partici-

pants have high incomes or high sav-

ings rates. In these situations, it

appears that sponsors are more will-

ing to add additional loans. But in

aggregate, it seems additional loans

do not necessarily lead to higher loan

exposure—assuming that they are

only offered to participants with

higher average balances.


70. Number of Loans Allowed

Percentage of Plans

62%

28%

10%

1 2 3+

Number of loans

0%

10%

20%

30%

40%

50%

60%

70%

80%


71. Loan Exposure by Number of Loans Allowed

Average loan amount

Average account balance

Percent of account balance in loan

1

$5,800

$39,600

15%

2

$7,400

$54,200

14%

3+

$8,100

$58,800

14%


Number of Loans

In-service withdrawals provide

participants with yet another means

of accessing plan savings in advance

of retirement. While most plans offer

this feature, it is used relatively

infrequently, and so does not con-

tribute materially to the problem of

“leakage” from employer-sponsored

retirement plans.

Availability

Among all Vanguard DC plans,

three-quarters allow in-service

withdrawals for financial hardships

or for participants who have reached

age 59 1/2 (the age at which the

10% tax penalty on premature plan

distributions no longer applies).

Most plans today require some prior

sponsor approval of withdrawals,

with only one-third utilizing preau-

thorized systems. Slightly more

than half require spousal approval

(see chart 72).

Impact

In-service withdrawals are used by a

small number of participants. They

account for an equally small percent-

age of plan assets (see chart 73).

In 2001, 3.5% of Vanguard partici-

pants in plans offering in-service

withdrawals used the feature, down

from about 5% in 1999. The assets

withdrawn totaled less than 1%

of Vanguard recordkeeping assets.

However, for participants taking

such withdrawals, the average with-

drawal increased from 14% of their

account balances in 1999 to nearly

20% in 2001.


72. In-Service Withdrawal FeaturesA

Percentage of Plans Offering

33%

1 2/

Automated service

51% Spousal consent requirement

Withdrawals after age 5974%

76% Hardship withdrawals


0% 10% 20% 30% 40% 50% 60% 70% 80%

73. Use of In-Service WithdrawalsAverage Recordkeeping Assets

19.6% Percentage of participantaccount assets withdrawn

0.7% Percentage of plan assetswithdrawn

3.5% Percentage of participants using


0% 5% 10% 15% 20%

In-Service Withdrawals

When changing jobs or retiring,

defined contribution plan participants

have the option of receiving their

plan savings in the form of a lump-

sum distribution. This money may

be rolled over to an IRA or other

qualified retirement plan, or it may

be spent. Participants can also keep

the money in their employer’s plan

if the value is more than $5,000.

Older or more affluent participants

tend to save their plan distributions.

However, among younger or lower-

balance participants, the spending of

plan savings—the problem of “leak-

age” from the retirement system—is a

significant concern. Participants who

spend their distribution face both

short-term and long-term costs. In

the short run, participants incur both

taxes and penalties on the amounts

spent. In the long run, because of the

lost opportunity for compound earn-

ings, they raise significantly the

amount they must save during the

rest of their working years.

In this discussion of distribution

behavior, we separately report on par-

ticipant behavior and the flow of

assets for each of these categories.

The calculations are based on several

simplifying assumptions, described

at the end of this section.

Participant and asset flows

Plan distributions occur reasonably

frequently as participants change jobs

or retire, and they represent a surpris-

ingly large portion of plan assets

and participants. In 2001, 12% of

Vanguard recordkeeping participants

became eligible for a plan distribution,

either due to a job change or retire-

ment. Their plan assets totaled 10%

of Vanguard recordkeeping assets.


74. Plan DistributionsP

By Percentage of Participants Choosing Option

32% Rollover

29% Remain in plan

1% Installment payments1% Rollover and cash


36% Cash lump sum

56% Rollover

32% Remain in plan

2% Installment payments

10% Cash lump sum

By Percentage of Assets Distributed

Plan Distributions and Rollovers

For all participants eligible for a plan

distribution in 2001, 6 in 10

Vanguard participants chose to pre-

serve their savings by rolling over

their assets to an IRA or other quali-

fied plan, or remaining in their

former employer’s plan (see chart 74).

Nearly 4 in 10 participants chose to

take their distribution as a cash

lump sum. About 1% of participants

chose to split their distribution

between saving and spending.

In terms of assets, 88% of all plan

assets eligible for distribution were

preserved—either rolled over to an

IRA or other qualified plan, or left in

the former employer’s plan. Only 12%

of assets were distributed in cash

(usually as a lump sum, but infre-

quently as installment payments).

Another way to look at these statistics

is in terms of the participant and asset

flows out of DC plans. In 2001, of

the 12% of Vanguard participants eli-

gible for a lump sum, only 3% chose

to retain their assets in their employ-

er’s plan. Most participants left their

employer’s plan—4% of participants

rolled over assets to an IRA, and 4%

took a cash lump sum. (Participants

combining rollovers and lump sums,

or taking installment payments,

accounted for the remaining 1%).

In terms of the 10% of assets available

for distribution in 2001, the decision

still favored leaving the plan, but

by a smaller margin. A total of 6%

of assets left the employer plan—5%

of assets went to an IRA rollover,

and 1% was distributed in cash. The

remaining 4% of assets remained

in the employer plan.


Vanguard results appear to be more

positive than reported in other

sources. In one study, based on plan

data from the early 1990s, 28% of

participants completed a rollover,

accounting for 56% of assets (see

chart 75). Nearly 8 out of 10 partici-

pants took distributions in cash.

Cash lump sums were used for a vari-

ety of purposes—current spending,

transfer to a taxable savings account,

debt repayment, or education,

housing, health, and other purposes.18

Determinants of distribution behavior

Age has a significant impact on

distribution behavior. Younger partici-

pants are less likely to preserve their

retirement savings. For example,

during 2001 just less than half of

participants in their 20s (45%) rolled

over their distribution to an IRA or

kept it in an employer plan. But

three-quarters of participants in their

50s did so (see chart 76). In terms

of assets, participants in their 20s

preserved slightly more than two-

thirds of their assets in an IRA or

employer plan, while participants

in their 50s preserved 95%.


75. Uses of Plan Distributions

Percentage of Assets

Rollover SpendingSavings/other accountDebtEducation/health/businessHouse purchase/mortgage


56.3%

13.2%

10.9%

7.5%

6.5%

5.6%

28.3%

28.8%

11.2%

17.3%

7.8%

6.6%

Source: Bassett, Fleming, and Rodrigues, 1998.

76. Plan Distribution Behavior by Age

Percentage of Participants Choosing

Rollover

Remain in plan

Cash lump sum

Installments

Rollover and cash

23%

22%

55%

0%

1%

20s

28%

29%

41%

0%

1%

30s

32%

32%

34%

0%

1%

40s

41%

34%

23%

1%

2%

50s

45%

28%

23%

2%

2%

60s

33%

14%

22%

26%

4%

70s

32%

29%

36%

1%

1%

Average

Percentage of Assets Distributed

Rollover

Remain in plan

Cash lump sum

Installments

40%

28%

32%

0%

20s

45%

40%

15%

0%

30s

47%

44%

9%

0%

40s

55%

40%

6%

0%

50s

59%

35%

6%

0%

60s

68%

21%

8%

4%

70s

53%

39%

8%

0%

Average


18 Bassett, Fleming, and Rodrigues, 1998.

The same demographic factors that

drive participation and contribution

rates also appear to influence distri-

bution behavior. In general, those

who invest their DC savings are

more likely to be older, have higher

incomes, be better educated, or own

a home. Those who spend their dis-

tribution are likely to be younger,

have lower incomes, have less educa-

tion, and rent rather than own

their home.19

The problem of “leakage”

The consumption of DC plan savings

prior to retirement—the problem

of “leakage”—poses a significant

challenge for plan sponsors, providers,

and policy-makers. As this data illus-

trates, the problem is most acute

for younger participants with smaller

account balances. These dollars are

small in the aggregate, but have

significant implications for these

participants’ future standard of living.

Through compounding, these small

amounts, if invested over a lifetime,

are more powerful than larger

sums accumulated later in life.

By consuming—rather than saving—

their small account balances when

they are young, participants face a

higher savings burden throughout the

rest of their working lives. See page

73 for additional information on

savings adequacy.

A word on methodology

In analyzing plan distribution

behavior in this section, we report

separately on participant behavior

and the flow of assets for each of the

categories. The asset calculations are

based on the actual dollar figures. The

participant calculations, however, use

several simplifying assumptions.

First, a participant who terminated

employment during 2001 and was

still classified as vested at year-

end is considered a participant who

has kept his or her savings in

their employer’s retirement plan.

Subsequently, the participant may

choose to roll over the assets to an

IRA or cash them out.

Second, any participant who rolled

over pre-tax assets but was obliged to

take after-tax assets as a cash distri-

bution was considered a rollover par-

ticipant. Meanwhile, the assets are

allocated, respectively, to the rollover

and cash lump-sum category. Third,

in the case of a combination rollover

and cash distribution, participants

rolling over more than 80% of assets

were classified as rollover participants;

rolling over less than 20% of assets

as a cash lump-sum participant;

and between 20% and 80% of assets

as a combination rollover/lump-

sum participant.


19 Bassett, Fleming, and Rodrigues, 1998.

Insights and Strategies

P A R T T H R E E

Today defined contribution plans play an important role in the national debate over U.S. retirement savings. As part of abroader pension and tax reform effort in 2001, Congress expanded the tax benefitsgranted to DC plans. This new legislation further strengthened the role of these plans in the U.S. employer-sponsored retirement system.

At the same time, a two-year

slide in U.S. equity prices has

raised concern about the nature

of risk in DC plans and, in

particular, participant reaction

to that risk. The stock market

decline, the most severe in a

quarter century, has not led

to widespread selling of stocks

by participants. But it has

prompted a debate over the role

of employer-versus-employee

risk-taking, the nature of retire-

ment guarantees, and the relative

merits of DB plans versus DC

plans. Perhaps most significantly,

the market decline highlighted

the risks associated with high

levels of company stock in the

DC plans of several well-known

companies, including Lucent

and Enron.

The decline in stock prices

has had another, possibly

beneficial effect—increasing

national interest in the adequacy

of retirement savings in the

U.S. Several years of negative

market returns have challenged

the belief that the capital

markets alone can be counted

on to deliver adequate retire-

ment savings. With current

returns posting in the negative,

and future returns likely to be

more modest, savings behavior

is now at center stage.

With renewed national focus

on savings rates, and the current

attention to diversification,

investment education, and

participant trading activity,

we examine five topics relevant

to DC plans:

• Boosting participation and

savings rates.

• How much should workers

save for retirement?

• The nature of restrictions

on company stock.

• Workers’ “money attitudes”—

the psychological attitudes

and beliefs that influence

savings behavior.

• Trading activity—a look

at the participants who

do transact in their account

year-to-year.

Boosting plan participation and sav-

ings rates remain ongoing priorities

for many plan sponsors. Employees

attach a high value to 401(k) benefits;

as a result, raising plan participation is

often a means of enhancing employee

loyalty and retention. Some sponsors

also have strictly pragmatic concerns:

Under nondiscrimination testing,

highly compensated employees are

limited in their ability to save through

a plan if lower-paid employees do

not participate adequately. Finally,

many employers are concerned about

savings adequacy—whether their

employees are putting aside sufficient

savings for retirement.

As noted in our discussion of partici-

pation rates (see page 28), while the

average plan participation rate is 76%,

the participation rate weighted by

number of participants is 65%, mean-

ing that about 1 in 3 participants fails

to join his or her employer’s DC plan.

In addition, the Vanguard median

savings rate is 6%, meaning half of

participants contribute 6% or less to

their employer’s plan. According to

our calculations, that savings rate is

only adequate for lower-income

workers whose employer provides

another generous retirement benefit

on top of the voluntary DC plan

(see page 73).

In this section we describe factors

influencing participants’ savings

behavior—both the initial decision

to join, or participate, in a retirement

plan, as well as the decision to save

at a certain level. A wide range of

factors appears to be important in

participants’ decisions. These include

participant demographic features

such as age, income, education, and

job tenure; plan features such as

employer matching contributions

and loans; plan education and com-

munications; and social and peer

group effects in the workplace. To

address the problem of adequate

participation and savings, some

sponsors are considering new plan

features such as automatic enrollment

or automatic (so-called SMarT)

savings programs.

Demographic factors

For plan sponsors seeking to boost

plan participation and savings rates,

the difficulty of the task is a direct

function of the demographics of their

workforce. Both income and age are

important determinants in workers’

decisions about whether to participate

and save in an employer retirement

plan. But a host of other factors come

into play as well, including level

of education, job tenure, and other

savings and wealth—including home

ownership (see chart 77).

Part 3 Insights and Strategies

Boosting Participation and Savings Rates

In general, if an employer’s workforce

has large numbers of young, short-

tenured employees with lower

incomes and lower levels of educa-

tion, both participation and savings

rates are likely to be below average.

Sponsors with such employees will

have to make special efforts to boost

participation and savings rates.

But if the employer’s workforce is

comprised of older, long-tenure

employees, with higher-average

incomes and levels of education,

demographics are conducive to high

rates of plan participation and sav-

ings. Sponsors with such workforce

characteristics should find it easier to

encourage savings behavior among

their employees.

Plan features and size

An employer match is one of the

strongest inducements to plan

participation. About two-thirds of

participants cite matching contribu-

tions as an important reason for join-

ing an employer-sponsored savings

plan.20 Several researchers have like-

wise found a positive statistical

relationship between an employer

match and a plan’s participation rate.21

The evidence is mixed, however, on

whether participation rates are a func-

tion of the size of the match. Some

studies suggest that it is not the size

of the match, but the mere existence

of a match, that boosts participation.22

Plan loans (available in DC plans

with a 401(k) arrangement) provide

participants with financial flexibility

during the working years, and so are

thought to be effective in encourag-

ing plan participation.23 Loans

allow participants to use what is

effectively a retirement savings plan

for other financial objectives, includ-

ing the purchase of a car or home,

college expenses, or emergency

spending. Anecdotally, many plan

sponsors have found that adding a

loan feature encourages participation

among younger workers—although

only 1 in 5 participants cited a

loan feature as the top reason for

joining a plan.24


77. Demographic Influences on Plan Participation

Less Likely to Participate

Factor

More Likely to Participate

Low income

Younger

New to job

High school or less

Renter

Other retirement plan

IncomeAgeJob tenureEducationHome OwnershipEmployer plans

High income

Older

Long-term employee

College or more

Home owner

Only 401(k) plan

Source: Bassett, Fleming, and Rodrigues, 1998; Hinz and Turner, 1998; Clark and Schieber, 1998.

20 EBRI/ICI, 2000b.21 Andrews, 1992. Papke, 1995. Papke and Poterba,

1995. Clark and Schieber, 1998. Even and

MacPherson, 1999. Munnell, Sundén, and

Taylor, 2000.22 Bassett, Fleming, and Rodrigues, 1998.23 Munnell, Sundén, and Taylor, 2000.24 EBRI/ICI, 2000b.

Plan size also influences participation

rates, with large plans having lower

participation rates than small plans.

One reason may be that large

employers are more likely to offer

another nonvoluntary DB or DC

plan. As a result, employees have less

incentive to save on their own.

Another reason may be that larger

firms find it more difficult to commu-

nicate the benefits of voluntary retire-

ment savings; in a large organization,

the impact of benefits communica-

tions may be more diffuse than in

smaller firms.

The role of education

Research has shown that workplace

financial education has a measurable

and dramatic impact on participant

behavior. Education is particularly

effective in boosting participation and

savings rates. Simply making educa-

tion available raises participation rates

11.8% in absolute terms (see page

49). And when employees actively

engage in workplace education pro-

grams, participation rates rise 19.5%.

The impact of education appears to

be strongest among low-balance par-

ticipants. High-balance participants

already participate and save at higher

rates; the marginal impact of educa-

tion is therefore rather limited. High-

balance participants also are con-

strained by IRS limits on their contri-

butions, and thus are restricted in

their ability to increase their savings

behavior in response to workplace

education.

Besides increasing participation rates,

education also boosts savings rates

(see page 49). When workplace edu-

cation is offered, participants save

more for retirement and have higher

retirement plan balances. They also

have higher total household savings

rates. In essence, through a spillover

effect, workplace education prompts

participants to take a comprehensive

look at all of their personal finances.

This even affects the spouses of non-

highly compensated employees, as the

spouses of participants with access to

workplace education have higher par-

ticipation and savings rates in their

own employers’ plans.25

These beneficial effects of education

were calculated based on companies

offering traditional communications—

e.g., simple plan communications in

print and employee group meetings.

Today there are new techniques, such

as personalized communications,

either in print or electronic form,

which are employed to boost partici-

pation and savings rates.

Another new strategy is to reformu-

late retirement communications based

on employees’ attitudes and beliefs

about retirement and financial

planning—their “money attitudes.”

Workers differ materially in their

interest in, and enthusiasm for, many

aspects of financial and money

management. Understanding these

psychological and attitudinal differ-

ences may help improve workplace

financial education programs. (See

page 83 for more on money attitudes.)


25 Bernheim and Garrett, 1996. Bayer, Bernheim, and

Scholz, 1996.

Social and peer group effects

One new research finding is that

participation rates are influenced not

only by traditional economic factors,

but also by the social and peer group

dynamics within an organization.

Plan sponsors have known for some

time that having strong “plan advo-

cates” within a location or division

can often dramatically boost partici-

pation and savings rates. New

research corroborates this intuition

and suggests that peer group dynam-

ics play an important role for

two reasons26:

• Plan participation is a complex

matter, and relying on peer groups

is a good way to gather information

and make decisions.

• Peer groups lead to common

thinking. An individual may want

to mimic the behavior of the work

group he or she belongs to, whether

that behavior is positive (joining

the plan) or negative (steering

clear of it).

Sponsors seeking to boost participa-

tion will want to look at ways to alter

or enhance peer group dynamics.

The aim of education is not simply

to alter individual behavior, but also

group attitudes and beliefs.

Automatic enrollment

Automatic enrollment—the manda-

tory enrollment of eligible employ-

ees—has emerged in recent years as a

technique to boost plan participation

rates. Under automatic enrollment,

the employer enrolls newly eligible

employees (or all eligible employees)

in a default investment fund at a

default savings rate. The employee

retains the right to “opt out” of the

arrangement—hence automatic

enrollment is sometimes described

as “negative elections.”

An automatic enrollment feature has

been adopted by a small but growing

number of sponsors. Among

Vanguard’s 401(k) clients, less than

10% of large plans (those with more

than $100 million) have adopted the

feature. Anecdotally, clients remain

interested in exploring this option.

Immediate interest has waned some-

what during 2001, however, as a result

of the economic downturn; few spon-

sors are interested in adding to their

current benefits costs in the form

of higher matching contributions for

automatic enrollment.

In a July 2001 survey of 15 Vanguard

clients offering automatic enrollment,

two patterns emerged.27 Sponsors

typically set low default savings rates,

with most choosing a default rate of

3% or less. About one-quarter of plan

sponsors chose a default savings rate

of 4% or more. While 40% of plan

sponsors chose balanced or life-cycle

funds for their default investment

option, 60% of clients made conserva-

tive choices—typically money market

or stable value funds.


26 Duflo and Saez, 2000, 2002.

27 Vanguard, 2001b. See also Profit-Sharing/ 401(k)

Council of America, 2001b.

Benefits to sponsors

The main benefit of automatic

enrollment is higher participation

rates. In the Vanguard survey,

average participation rates jumped

from 75% to 84% for plans auto-

matically enrolling newly eligible

employees (see chart 78). In some

cases, higher participation improved

the likelihood that a plan will pass

nondiscrimination tests.

Another benefit of automatic enroll-

ment is the reduction in differences in

participation rates among employee

subgroups. For example, a study

of one large company showed that

automatic enrollment virtually elimi-

nated differences in participation

rates due to income, age, job tenure,

and other factors.28

A long-term solution?

Along with plan sponsors, policy-

makers in Washington, D.C., have

advanced automatic enrollment as a

solution to the problem of nonpartici-

pation in voluntary DC plans. Yet it is

not without its drawbacks, including:

• Inertia. After automatic enrollment,

many participants remain at default

savings rates and in default invest-

ments. For many automatically

enrolled participants, savings rates

are too low and investments are too

conservative to accumulate a mean-

ingful retirement income.29

• Reliance on the default choices.

When automatic enrollment is

introduced, some participants

who would have chosen to enroll

in the plan don’t make a conscious

choice—instead, they rely on the

automatic enrollment defaults. As

a result, they end up saving at lower

rates and investing in more conser-

vative options than they would

have on their own.30

• Matching and administrative costs.

The most obvious cost associated

with automatic enrollment is the

employer’s cost of additional

matching contributions. Sponsors

also face higher administrative

costs. Sponsors incur recordkeeping,

education, and account-servicing

costs for many low-balance

accounts. In a plan with high

employee turnover, the costs of

processing these small accounts can

soar. Low-balance accounts are

also low-revenue accounts for

providers, which can mean higher

fees over time.31


78. Impact of Automatic Enrollment on Participation Rates

Plan Participation Rate (for Newly Eligible Participants)

75%84%

Before automatic enrollment After automatic enrollment

Source: Thaler and Benartzi (forthcoming).

0%

20%

40%

60%

80%

100%

28 Madrian and Shea, 2001.

29 Choi, Laibson, Madrian, and Metrick, 2001a.30 Choi, Laibson, Madrian, and Metrick, 2001b.31 Vanguard, 2001a.

McDonald’s Corporation’s decision to

discontinue its automatic enrollment

program is a case in point, in particu-

lar because the company was among

the first to roll out the program.

According to published media

reports, automatic enrollment simply

increased participation rates among

“marginal participators.” McDonald’s

felt it should spend more of its own

money, in the form of matching con-

tributions, on long-tenure employees

who were saving responsibly for

retirement. As a result, the company

adopted a safe-harbor plan, which

meant higher contributions for the

safe-harbor match, but with none of

the headaches (or costs) of nondis-

crimination testing.32

The SMarT Plan33

In their efforts to encourage higher

savings, sponsors face a critical obsta-

cle: employee inertia. Inertia keeps

employees from taking action, such as

increasing savings rates over time.

Inertia is also self-perpetuating.

After contributing at a given rate for

years, employees can come to believe

that their current savings rate is the

only rate they can afford. The stan-

dard advice of a financial planner—

that most people could save another

5% of income with no noticeable

effect on their standard of living—

falls on deaf ears.

How might plan sponsors use natural

inertia to move workers onto the path

of saving adequately for the future?

One solution is to institutionalize a

“save your raise” philosophy as a fea-

ture of the plan. Financial planners

often advise clients to “save your raise

each year,” or at least a part of it. But

most participants, whether due to

inertia or lack of interest or time, can’t

or won’t do it on their own.

Two researchers, Professors Shlomo

Benartzi of UCLA and Richard

Thaler of the University of Chicago,

have designed a “save your raise” plan

that relies on inertia. They call the

program the SMarT plan—Save More

for Tomorrow.34 The researchers are

well-known proponents of behavioral

finance—an academic discipline

that attempts to integrate the

tenets of human psychology with

modern finance.

How SMarT works

Under an automatic savings or

SMarT feature, participants sign up

today to have their plan deferral rate

increased in the future, typically

(though not necessarily) at the next

merit review or pay increase. The

increase is a set amount—for exam-

ple, 1% or 2% of pay. There is also a

cap, such as 10%. For example, a par-

ticipant saving 3% today might sign

up for a 1% SMarT feature. At the

time of the next pay or merit increase,

the participant’s deferral rate would

rise by 1% to 4%. In the following

year it would increase to 5%; in the

next, to 6%; and so on, until reaching

the cap of 10%. With the SMarT

program, once the initial commitment

is made, regular increases to savings

occur automatically.


32 Plan Sponsor, 2002, pp. 16-17.33 See Thaler and Benartzi (forthcoming) and

Vanguard, 2001b for additional background on the

SMarT plan. 34 Thaler and Benartzi (forthcoming).

The SMarT plan makes clever use

of participant psychology. Participants

find it easy to join because signing up

for the service has no immediate

financial impact. When the partici-

pant’s contribution to the plan is

increased, any pain from the higher

deferral rate may be offset by a merit

or a cost-of-living increase. Depending

on the increase, a 1% or 2% boost in

the deferral rate may be nearly invisi-

ble in the participant’s paycheck.

Participants also observe the modest

impact that additional savings has on

their paycheck. They can see firsthand

what financial planners preach—a

small boost in savings has virtually no

financial impact and is easy to live

with. Finally, if they balk at the idea

of higher savings, most—through

inertia—don’t take the time to cancel

the program.

Initial SMarT results

Thus far, Professors Benartzi and

Thaler have tested the SMarT program

at one medium-size company, a 300-

person manufacturer, with very prom-

ising results. There, average deferral

rates more than doubled over three

pay raises—a period of about 28

months (see chart 79). The challenge

is whether these results can be repli-

cated more broadly.

A multidisciplinary approach

As the research in this section

implies, no single technique or pro-

gram seems likely to address the

problem of low participation and sav-

ings rates in DC plans. Instead, what

appears to be required is a multidisci-

plinary approach, a strategy that relies

on multiple tools to address the

resistance and inertia associated with

some workers’ unwillingness to save

for the future.

A multidisciplinary strategy will be

built from a number of complementa-

ry techniques. Plan design features

like matching contributions and loans

are essential; education programs

remain powerful tools. For sponsors

looking to enhance their participation

or savings programs, there are also

new techniques to be considered. In

plan design, features like automatic

enrollment or SMarT savings programs

need to be evaluated; in education,

personalized communications or

strategies targeting workers’ money

attitudes should play a role. And any

comprehensive approach must consid-

er not just the individual employee,

but the peer group and social environ-

ment of the organization as well, so

as to create a culture that encourages

and promotes savings behavior in

the workplace.


79. Impact of Automatic Savings on SMarT Feature

Average Savings Rate

4.4%

9.8%

8.6%

7.1%

Prior toProgram

After FirstPay Raise

After SecondPay Raise

After ThirdPay Raise

Source: Benartzi and Thaler.

Duration

0%

2%

4%

6%

8%

10%

As sponsors and providers seek to

encourage retirement savings, an

essential question to consider is:

How much should workers be saving

for their retirement? In this section

we summarize some of the recent

research on the adequacy of retire-

ment savings in the U.S., and then

provide our estimates of how

much workers should be saving to

achieve a comfortable retirement.

Comprehensive look

Analyzing the adequacy of Americans’

retirement savings requires compre-

hensive household financial data,

including information on:

• Social Security.

• Employer-sponsored retirement

plans, including DB pension bene-

fits and DC account balances.

• Personal savings, whether held

in bank accounts, mutual funds,

brokerage accounts, or insurance

products.

• Housing equity.

For the median (50th percentile) U.S.

household approaching retirement,

these sources of retirement wealth are

sometimes referred to as the “rule of

fifths.” For the typical household,

Social Security accounts for about

two-fifths of retirement wealth;

employer plans, personal savings, and

housing equity account for another

one-fifth each (see chart 80).35

Savings among preretirees

To examine whether American work-

ers are saving enough for retirement,

several studies have relied on a

national survey of preretirees known

as the Health and Retirement Study

(HRS). The HRS is tracking more

than 8,000 households nationwide in

their 50s and 60s; the aim is to follow

this group through their remaining

work years and retirement.36 One

study drawing on HRS results found

positive news—the average U.S.

household approaching retirement

appeared to have adequate levels of

savings. Looking beneath these aver-

ages, about 2 out of 3 preretirees

appeared to have adequate levels of

wealth for a retirement income; but a

large group, one-third of preretirees,

did not.37


80. Retirement Wealth of PreretireesP

41% Social Security

21% Financial assets

Source: Moore and Mitchell, 1997.

20% Employer plan

18% Housing

35 Moore and Mitchell, 1997.

36 The first wave of HRS tracked about 8,000 house-

holds age 51 to 61 in 1992; updates to the study are

made every three years.37 Gustman and Steinmeier, 1998.

How Much Should Workers Be Saving?

A second study of preretirees looked

at the amount households would need

to save until retirement to fund an

adequate standard of living. It found

that the typical (median) preretiree

household would need to save 16%

of income until retirement in order

to retire by age 62. But that same

median household would need to save

only 7% of income if retirement were

delayed until age 65. This result

would suggest that, by varying savings

rates and retirement dates, the average

U.S. household was well on its way to

a reasonably comfortable retirement.38

But looking beneath the averages,

there was much variation in the level

of preparation for retirement. Based

on the results of this second study,

American preretirees could be divided

into three camps (see chart 81):39

• The well prepared. Thirty percent of

American preretirees are well pre-

pared for retirement. To retire by

age 65, this group needs no addi-

tional savings.

• The potentially secure. Another 30%

of American preretirees have accu-

mulated meaningful retirement

wealth, but still need to save more.

To retire by age 65, they need to

save up to 9% of their income

until retirement.

• The “at risk” households. Forty percent

of American preretirees are financial-

ly vulnerable and will suffer a large

drop in their standard of living at

retirement. To retire by age 65, this

group would need to save at double-

digit rates (from 14% to 27% of

income). But many of these house-

holds are low income and lack the

resources to attain such savings rates.

All in all, this study suggests that 6 in

10 households approaching retirement

seem on track financially, while 4 in

10 households are at high risk for not

meeting reasonable retirement goals.

A third study focused on all U.S.

households, not just preretirees,

provided similar results. In that

report, the typical (median) U.S.

household seemed on track for retire-

ment. At the same time, there was

strong evidence that the bottom 25%

of households were clearly unprepared

for retirement. The other 25% fell

somewhere in between.40


81. Retirement Readiness of PreretireesP

Percentage of Preretiree Households by Level of Retirement Security

30% Well prepared

40% At risk

30% Potentially secure

Source: Vanguard summary from Moore and Mitchell, 1997.

38 Moore and Mitchell, 1997.39 Our classification adapted from Moore and

Mitchell, 1997. 40 Engen, Gale, and Ucello, 1999.

The case for additional savings

These research studies confirm that a

majority of American households are

either well prepared or reasonably on

track for a comfortable retirement.

But there are several reasons why the

outlook may not be as sanguine:

• Interest in early retirement. Most of

these studies show positive results if

individuals retire at 65. Yet today,

half of all workers retire by age 62,

and national surveys indicate that

many workers want to retire in their

early 60s.

• Longevity risk. At the same time

that workers want to retire earlier,

increases in life expectancy also

mean a longer period in retirement.

Workers must not only plan for the

years prior to eligibility for Social

Security and Medicare; they must

also consider the resources needed

over a longer life. The growth of

DC plans also means a greater

reliance on lump-sum distributions.

Individuals living off lump-sum

payments will need more money to

“self insure” against their own

longevity risk—the risk of living

long and running out of money.

• Reduced Social Security benefits.

According to the system’s trustees,

Social Security benefits are likely to

be lower for the baby boom genera-

tion—by as much as 30%—if the

system is not reformed. And some

reform proposals may require addi-

tional savings by workers.

• Health care costs. Medicare, the

health program for those older than

65, is also facing a financial crisis

because of baby boom demograph-

ics and rising health care costs.

Facing these same cost pressures,

many large employers are reducing

retiree health benefits (most small

companies don’t even offer them).

And Medicaid, the program for the

poor that pays for nursing homes

for most older Americans, is also

facing a financial crunch.

Finally, many national estimates of

retirement needs assume that retirees

will trade down in their housing and

spend their house equity during

retirement. Yet according to some

researchers, most retirees don’t actually

use their home equity for retirement,

except in a time of crisis, such as

entry into a nursing home.41 So

retirement savings calculations that

rely on spending housing equity may

be too optimistic.

All of these concerns provide

the impetus for additional retire-

ment savings.


41 Venti and Wise, 2000, 2001.

What constitutes adequate savings?

At what rate, then, should individual

workers be saving for retirement? A

precise answer to that question is

impossible without knowing a work-

er’s complete financial picture, espe-

cially the details of employer plans

and personal savings. Some also

would argue that retirement forecasts

should also be based on the worker’s

health profile and a customized esti-

mate of life expectancy.

That said, it is possible to estimate

some broad guidelines across the

working-age population. We assume

that individuals will want to replace

75% of their preretirement income.

We also assume that they will save

for retirement over 30 years—say,

from age 35 to 65. (While many indi-

viduals do start saving at an earlier

age, a majority of young plan partici-

pants cash out their retirement

plan distributions.)

Two other issues are critical to calcu-

lating retirement needs—the types of

employer retirement plan offered to a

worker, and the likely benefits expect-

ed from Social Security. We look at

two different scenarios:

• DC versus DB/DC coverage. In

terms of employer plan coverage,

two hypothetical workers, Worker

A and B, each has access to a DC

plan arrangement for 30 years.

Worker A saves through a DC plan

for his entire savings period.

Worker B, besides saving through

a DC plan, also spends the last

20 years of his career at a large

employer sponsoring a DB plan.

In the latter case, the DB pension

plan pays a level of benefit typical

of a large company—11/2% of the

worker’s final five-year average

salary for each year of service.42

• Social Security benefits. In one sce-

nario, each worker receives currently

scheduled Social Security benefits;

in a second, we assume that some

type of Social Security proposal is

implemented, and the net impact is

that benefits are reduced by 15%,

meaning that each worker needs to

make up the difference.

In the first scenario, with full Social

Security benefits and saving only

through a DC plan, Worker A has a

target retirement savings rate of 11%

to 20% of annual pay (see chart 82),

depending on income. This figure

includes both employer and employee

contributions. For example, if Worker

A earns $50,000, the target savings

rate is 15% of income. If Worker A’s

employer makes a 3% matching con-

tribution and a 2% profit-sharing

contribution, Worker A has to save

the balance—10% of salary.

Worker B’s target savings rate is lower

because his employer also sponsors a

DB pension plan, which in this case

is paid for by the employer. If Worker

B earns $50,000, for example, the tar-

get savings rate is 9%. Again this is

the amount of total savings from both

employer and employee contributions

in the DC plan.


42 For a 20-year employee, this benefit works out

to be about 22% of the worker’s final-year salary.

Importantly, the DB pension is not integrated

with Social Security; in other words, the benefit

value is not reduced based on Social Security

benefits received.

What happens if Social Security

benefits are reduced by 15% in our

example? Target savings rates are 2%

to 3% higher (see chart 83). This

may seem like a small amount of

additional savings, but keep in mind

that it is calculated over a 30-year

period. More likely than not, if Social

Security benefits were reduced, many

workers would have fewer than 30

years to make up the difference.

A retirement savings gap

These calculations confirm what

research studies suggest—that for

many households, there is still a sav-

ings gap when it comes to retirement

security. Today the typical employee

is saving 6% of his or her salary

in a DC plan. Assuming a typical

employer matching contribution

of 50 cents on the dollar (up to

6% of pay), the total retirement

savings rate for the typical DC plan

participant is 9%.

However, a 9% total savings rate in a

DC plan is appropriate in only limit-

ed circumstances. According to our

calculations, it is satisfactory for low-

and middle-income workers who have

a generous DB plan and who plan to

spend the last 20 years of their work

life accruing a benefit in that plan.

For most other workers, though, sav-

ings rates need to be higher to fund a

comfortable retirement. Moreover, as

our calculations indicate, required sav-

ings rates are even higher if Social

Security reform leads to some reduc-

tion in benefits. Higher savings rates

are also crucial in addressing concerns

not captured in our calculations,

including the desire for early retire-

ment, increased life expectancy and

longevity risk, and the rising costs of

health care in retirement.


82. Target Retirement Savings Rates

Worker A(DC only)

Worker B(DB/DC)

Current Income

$ 25,000

$ 50,000

$ 75,000

$ 100,000

5%

9%

12%

14%

11%

15%

18%

20%

Plan Coverage

Note: Based on 75% replacement income ratio; full Social Security benefits; moderately aggressive investment assumptions (60–80% in equity investments); for Worker B, 20–year DB coverage replacing 22% of final average pay. High-income participants may be limited in their ability to achieve these savings rates through a qualified plan. Source: The Vanguard Group, 2002.

Percentage of Income That Must Be Saved for Retirement Over 30 Years(Employee and Employer Contributions)

83. Target Retirement Savings Rates With Reduced Social Security

Worker A(DC only)

Worker B(DB/DC)

Current Income

$ 25,000

$ 50,000

$ 75,000

$ 100,000

8%

11%

14%

16%

14%

18%

20%

22%

Plan Coverage

Note: Based on 75% replacement income ratio; 15% reduction in Social Security benefits; moderately aggressive investment assumptions (60–80% in equity investments); for Worker B, 20–year DB coverage replacing 22% of final average pay. High-income participants may be limited in their ability to achieve these savings rates through a qualified plan. Source: The Vanguard Group, 2002.

Percentage of Income That Must Be Saved for Retirement Over 30 Years(Employee and Employer Contributions)

The double-digit decline in stock

prices over the past two years has

raised concerns about plan partici-

pants’ possible reactions to market

volatility. But it has also highlighted

the dangers of concentrated positions

in company stock held in some

defined contribution plans. Workers

at a number of well-known compa-

nies, including Lucent and Enron,

lost substantial sums, and in some

cases their entire plan savings, as a

result of stock market losses or com-

pany bankruptcy.

The role of company stock in retire-

ment plans has drawn scrutiny from

policy-makers in Washington, D.C.,

and various reform proposals have

been presented to either encourage or

mandate greater diversification. The

policy debate has focused in part on

the restrictions imposed on partici-

pants’ ability to diversify employer

contributions made in stock; another

concern has been whether partici-

pants adequately understand the risks

associated with high levels of compa-

ny stock holdings. A national survey

of DC plan participants conducted by

Vanguard, for example, shows that

participants view company stock as a

safer investment than a diversified

equity fund.43

In this section we provide informa-

tion on overall exposure to company

stock, as well as an overview of the

restrictions imposed by employers on

company stock holdings. The findings

are based on a mid-2001 survey of

Vanguard recordkeeping clients.44

Overall asset allocation to stock

Company stock accounted for 14% of

Vanguard’s total DC assets in 2001,

which includes plans offering and not

offering company stock as an option.

Measured in terms of only those plans

offering company stock as an option,

company stock accounted for 25% of

Vanguard DC assets. These figures are

somewhat below the averages reported

by government and industry statis-

tics—that 16% to 19% of total assets

in DC plans are invested in company

stock and that 29% of total assets of

plans offering stock are invested in

company stock.45

As also discussed previously, a plan’s

asset allocation to company stock

varies by plan size. Larger plans have

a greater exposure to company stock

than smaller plans (see page 45).

While large and small plans have

similar allocations to equities, in large

plans company stock substitutes for

holdings in diversified stock funds.


43 See Vanguard, 2002a, p. 6.

44 A more complete discussion of the role of company

stock in employer-sponsored retirement plans can

be found in Mitchell and Utkus, 2002.45 Mitchell and Utkus, 2002.

Restrictions on Company Stock

Participant and plan exposure

Concentrated holdings in company

stock are not widespread across all

Vanguard plans but are associated

with a specific group of plans and

participants (see chart 84). In terms

of plans, only 15% of Vanguard DC

plans offered company stock as an

investment option in 2001—10% had

concentration levels of 20% or less

of assets in company stock and 5%

had concentration levels exceeding

20% of assets.46

While the percentage of Vanguard

plans offering company stock is small,

the percentage of participants having

access to company stock is consider-

ably higher. The reason is that large

plans (with more participants) are

more likely to offer company stock

and have higher levels of concentrated

holdings in it. For example, half of all

Vanguard plans with more than 2,500

participants offered company stock in

2001, compared with only 4% of plans

with fewer than 500 participants. As a

result, while a small minority (15%) of

Vanguard DC plans offered company

stock, a slight majority (53%) of

Vanguard recordkeeping participants

had access to company stock in their

employer’s plan.

Of the 53% of Vanguard participants

with access to company stock, 22%

were offered the option but declined

to invest in company stock. In some

plans, particularly of medium- and

small-sized firms, company stock is

simply another investment option in

which participants can choose not to

invest. In some plans, employer con-

tributions are often made in cash;

if they are made in stock, they may

not be subject to restrictions on

diversification. Another 12% of par-

ticipants had positions in company

stock of up to 20% of their account

balance. Finally, about 1 in 5 Vanguard

participants (19%) had both access to

company stock and positions exceed-

ing 20% of their account balance.


84. Plan and Participant Exposure to Company StockP

Percentage of Plans

5% Allocation more than 20%

10% Allocation of 1%–20%

85% Not offered


47% Not offered 19%

Allocation more than 20%

12% Allocation of 1%–20%

22% Offered but 0% invested


46 As of mid-2001, company stock was offered by 264

qualified Vanguard record-keeping plans, sponsored

by 173 separate client organizations.

Directed versus discretionary plans

Concentrated positions in company

stock are influenced by both partici-

pant behavior and plan design.

Participants appear to believe that

company stock is a safer equity

investment than a diversified equity

option, despite the higher risks asso-

ciated with individual stocks.

Participant investment decisions are

also highly influenced by past per-

formance. If a stock’s performance

has been strong, participants will

allocate a large portion of their sav-

ings to it; if a stock’s performance

has been weak, they will avoid it.47

At the plan level, sponsors have two

decisions to make about company

stock. The first is whether employer

contributions should be made in cash

(i.e., left to the discretion of the

employee to invest) or in shares of

company stock. The second decision

is what types of restrictions, if any,

should be imposed on company stock

holdings in the plan, whether made

by the employer or the employee.

Some restrictions may be positive

(i.e., enhancing diversification) by

limiting participants’ ability to hold

concentrated stock positions; others

may be negative in that they dis-

courage or prohibit diversification of

company stock; still others may be

neutral, meaning that the restric-

tions, such as trading rules, are

designed for other purposes and

are not intended to encourage or

inhibit diversification.


47 See Benartzi, 2001.

Among Vanguard plans offering com-

pany stock, 45% are directed plans,

where the employer makes a match-

ing or other contribution in stock.

Fifty-five percent are discretionary

plans, where investment decisions

about the employer contribution are

left to the employee. Again, plans that

direct contributions, like plans with

company stock, generally are more

likely to be large plans. As a result,

of the Vanguard participants with

access to company stock in their

employer plans, 52% are in directed

plans that match in stock and 48%

are in discretionary plans that

match in cash.

Restrictions

Our analysis of restrictions on com-

pany stock indicates that employer

restrictions vary considerably depend-

ing on whether the plan is directed

or discretionary (see chart 85a and b).


85. Restrictions on Company Stock

Impact on Diversification Restriction

Number

Imposing Category %

Age/service/vesting limitsRestricted until terminationMandatory holding periodMinimum % in company stock

No restrictionsCaps/maximums

Trading limitsOther

Negative

Positive

Varied

Total:

% of Total

4525111

166

512

121

37%21%9%1%

13%5%

4%10%

100%

68%

18%

14%

100%

Discretionary Plans—Restrictions Imposed by DC Plans With Discretionary Contributions to Company Stock(114 plans, 124 plan/fund combinations*)

Impact on Diversification Restriction

Number

Imposing Category %

No restrictionsCaps/maximums

Age/service/vesting limitsRestricted until terminationMandatory holding period

Trading limitsOther

Positive

Negative

Varied

Total:

% of Total

6025

652

719

124

48%20%

5%4%2%

6%15%

100%

69%

10%

15%

100%

* Some plans have more than one company stock fund; e.g. the stock of the current employer plus common stock of previous acquisition or merger partners. Source: The Vanguard Group, 2001.

Directed Plans—Restrictions Imposed by DC Plans With Contributions Directed to Company Stock(106 plans, 121 plan/fund combinations*)

a

b

Among the directed plans that match

in stock, nearly 7 in 10 restrict diver-

sification by participants in some way.

The most common way to restrict

diversification is through age or ser-

vice limits (including the statutory

ESOP limit of age 55 and ten years

of service). Some restrict diversifica-

tion completely until termination or

retirement. A small number require

a mandatory holding period.48

By comparison, discretionary plans

that match in cash are likely to

encourage flexibility and diversifica-

tion. Nearly 7 in 10 plans extend full

diversification rights to participants,

or they impose caps to discourage

concentrated holdings in company

stock. Somewhat contradictorily, a

small number of plans that allow

participants to make all investment

decisions impose a restriction (based

on age, service, etc.) if participants

choose to invest in company stock.

Based on these results, it appears that

restrictions are an important factor

when deciding between making the

employer contribution in stock or in

cash. Directed plans, with the match

in stock, are more likely to restrict

participants’ ability to diversify.

Discretionary plans, with the match

in cash, are more likely to allow full

participant diversification, or they

impose restrictions on participants’

ability to hold a concentrated position

in company stock.

Impact on concentration

Both the employer decision to direct

contributions to stock, and any related

restrictions, appear to have a mean-

ingful impact on whether or not par-

ticipants have concentrated holdings

in company stock. Among Vanguard

clients, directed plans have an average

allocation to company stock of 38%,

while discretionary plans have an allo-

cation to company stock of 17%. In

the broader industry, a similar pattern

prevails. Directed plans have an aver-

age allocation to company stock of

48%, while discretionary plans have

an average allocation to company

stock of 20%.49

In light of the controversy surrounding

company stock holdings, a number

of prominent employers have chosen

to eliminate or significantly reduce

restrictions on participants’ ability

to diversify employer stock contribu-

tions. Other employers are also

examining ways to increase partici-

pant awareness of risk, including

targeted education campaigns.


48 Many employers impose multiple restrictions on

diversification—e.g., an age and a service limit, plus

limits on trading to accommodate SEC earnings

black-out periods or to counter stock day-trading by

employees. Our analysis presents only the primary

restriction for each company stock fund. Also, we

have focused only on active company stock funds;

some plans have frozen funds/wasting assets, which

we have excluded from this analysis. 49 See Mitchell and Utkus, 2002.

Recent stock market turmoil has

again highlighted the importance of

investment and retirement education

in defined contribution plans. There

has been a dramatic expansion of par-

ticipant communications over the past

decade, and a corresponding shift in

focus from plan enrollment to the

broader retirement and financial plan-

ning needs of workers. As communi-

cations efforts have grown, plan spon-

sors have also expressed an interest in

new techniques that will enhance

effectiveness.

In many ways, benefits communica-

tions are like other forms of market-

ing communications—the aim is to

elicit certain “buying behavior.” In the

case of retirement plan communica-

tions, the intended buying behavior is

to induce employees to join the plan,

save at an adequate rate, and appro-

priately diversify investments.

One element essential to improving

the effectiveness of these communica-

tions is to tailor programs to the spe-

cific needs of an audience. Today plan

sponsors use a variety of methods to

target their communications, includ-

ing participant demographics and

plan status (e.g., nonparticipants, low

savers, conservative investors).

Another approach is to target plan

communications based on attitudinal

segmentation of the target audience—

developing communications that

reflect the audience’s attitudes toward

financial and retirement planning.

The material that follows summa-

rizes the major money attitude seg-

ments of the employee population

found in DC retirement plans. A

more detailed analysis of these results

can be found in a separate publica-

tion by the Vanguard® Center for

Retirement Research.50


50 Vanguard, 2002b.

“Money Attitudes” andRetirement Communications

What is attitudinal segmentation?

Attitudinal segmentation is a widely

used marketing technique that

employs soft psychological variables

such as preferences and beliefs to

define a target market, in addition to

hard demographic variables such as

age or income.

Many companies use a combination

of hard demographic segmentation

and soft psychological segmentation

in targeting consumers and markets.

For example, an operator of business

hotels might target specific demo-

graphic variables in its marketing

efforts—e.g., high-income profes-

sionals who travel for a living. But it

might also augment this strategy by

targeting specific attitudes or interests

of the target audience, such as con-

venience, cost-effectiveness, or a busi-

ness-savvy approach to client service.

In retirement plans, sponsors can

design retirement communications

around hard demographic or plan

variables, such as a campaign to pro-

mote plan participation among young

workers or a preretirement seminar

for those older than 50. But sponsors

also can design communications

around soft characteristics such as the

audience’s level of interest in financial

and retirement planning; its attitude

toward savings and the future; and its

level of interest in investment risk-

taking. We call these psychological

variables money attitudes.

Methodology

The five attitudinal segments

described in this report were created

as part of our multiphase research

program. The first phase, conducted

in 1999, consisted of in-depth inter-

views with a group of workers, which

included active plan participants, eli-

gible nonparticipants, and recent

retirees (within the previous five

years). The results from these inter-

views were used to create hypotheses

about potential attitudinal segments.


In 2000 these hypotheses were tested

with a quantitative survey of partici-

pants and eligible nonparticipants

drawn from Vanguard recordkeeping

clients. Subsequently, in 2001 these

results were validated against a

national random sample of retirement

plan participants. The results are

generally projectable to the national

retirement plan population (with

some differences as noted in the

separate Vanguard report).

Five money attitudes

Retirement plan participants fall into

five money attitude segments (see

chart 86). Two types of Planners—

Successful Planners and Up &

Coming Planners—together repre-

sent about half of the retirement plan

population, which includes partici-

pants and nonparticipating eligible

employees. Another fifth of the

retirement plan population falls into

a third category, Secure Doers. A

third of the population consists of

two types of Avoiders—Stressed

Avoiders, who are anxious about

money matters, and Live-for-Today

Avoiders, who focus on current grati-

fication rather than future rewards.


86. Five Money Attitude Segments

Percentage of Retirement Plan Population*

33% AvoidersStressed (19%)Live-for-Today (14%)

47% PlannersSuccessful (21%)Up & Coming (26%)

20% Secure Doers

* Includes both participants and eligible nonparticipants. Statistics based on Vanguard recordkeeping population, which may differ from national sample. Source: The Vanguard Group, 2002.

Planners have a strong vision about

the future and about retirement.

Retirement is not simply the end of a

primary work career; it is seen as a

new lifestyle, a new opportunity.

Planners envision specific goals for

the future—where and how they’ll

live, what activities they’ll pursue—

and are intent on realizing this vision

(see chart 87).

The two types of Planners share

many characteristics, but they differ

largely in age and self-confidence.

Successful Planners enjoy planning

and managing money. They are

disciplined savers and participate in

their employer’s DC plans at high

rates (90%). Successful Planners are

optimistic about and confident in the

success of their retirement plans, and

willingly take equity market risks

in pursuit of their goals.


Vision of retirement

Interest in retirement and financial planning

Savings behavior/deferral of gratification

Plan participation rate*

Preparation for retirement

Equity risk-taking

Sources of financial information

Other

Possess a strong vision with clear goals and aspirations

Enjoy planning and dealing with finances; derive satisfaction from managing money

Disciplined savers; derive satisfaction from saving

90%

Optimistic they will meet retirement goals; least concerned about having enough money

Willing to take risks for higher returns

Many—plan provider, media, Internet, adviser, employer

Older and more affluent; more active with the Internet

Similar to Successful Planners but with some uncertainty

Enjoy dealing with finances, planning, money management

Disciplined savers; enjoy savings process

81%

Not yet in a position to meet retirement goals but optimistic about the future

Have made money in stocks, but are less confident than Successful Planners

Many, like Successful Planners

Younger than Successful Planners

Less goal-focused; willing to adjust lifestyle to resources

Strong interest in saving for the future, but not as concerned with planning or managing their money

Willing to save for future

71%

Optimistic about retirement; likely to save sufficiently for future

Less willing to take equity market risk

Employer, plan provider, or adviser

Older and more affluent

Successful Planners(21%)

Up & Coming Planners(26%)

Secure Doers(20%)

Planners (47%) Doers (20%)

87. Five Money Attitudes—Highlights

* Participation rates were statistically different at a 90% confidence level (except for both Avoider groups). Note: Percentages shown are of a random sample drawn from more than 2 million Vanguard participants and eligible nonparticipants. Source: The Vanguard Group, 2002.

Up & Coming Planners are Successful

Planners in the making. Up &

Coming Planners enjoy retirement

planning and saving for the future;

they have an optimistic outlook and

they are stock market-oriented. While

they feel they are on track to realizing

their goals, they are somewhat less

confident about the future success

of their planning efforts.

Secure Doers, the third segment, are

quite different from Planners. They

take a highly disciplined approach to

saving for the future. But while they

are committed to saving, they don’t

find financial planning rewarding.

For Secure Doers, low involvement

in money matters is typical. They do

not enjoy managing finances. Secure

Doers are busy with other things in

their lives, such as family or career.

They are sometimes found in the

professions, as well as among entre-

preneurs—individuals who are

interested in their work but not in

managing their money.

The two Avoiders segments account

for one-third of the retirement

plan population. Both Avoiders

segments are characterized by low

participation rates, but they differ

markedly in terms of motivation.

Stressed Avoiders are anxious and

confused about money matters.

This anxiety impedes their savings

behavior and leads to pessimism

about the future.

Live-for-Today Avoiders aren’t stressed

about financial matters; they simply

have little or no interest in planning

for the future. Deferring gratification

is not high on their agenda, nor is

worrying about their future retire-

ment needs. Live-for-Today Avoiders

are simply focused on today’s con-

sumption and today’s spending.


Worried about future and money; not goal- or vision-oriented

Stressed out and confused by financial planning, money—but interested in learning more

Saving impeded by confusion, worry

62%

Pessimistic about having enough money for retirement

Least confident of their investment skills

Employer, plan provider

Nonparticipants regret not having joined plan; participants wish they had started sooner

Not focused on the future at all

Little interest in planning; not stressed; would rather “live for today“ than “plan for tomorrow“

Little satisfaction from saving; leisure time more valuable; retirement too far away

64%

Have not considered retirement needs; have highest degree of confidence in Social Security

Middle-of-the-road attitudes toward risk-taking

Employer, plan provider

Somewhat younger than all other groups

Stressed Avoiders(19%)

Live-for-Today Avoiders(14%)

Avoiders (33%)

Using money attitudes

Money attitudes can be used in

designing communications and in

potentially improving their effective-

ness. Each money attitude segment

has distinct interests in retirement

and financial matters. Some sponsors

may choose to identify one or two

segments as the target audience for

most of their plan communications.

Others might choose to vary their

approach from year to year, targeting

the needs of different audiences.

Whichever approach is taken, money

attitudes can be used to improve

existing communications strategies:

• Enrollment. The lesson from money

attitudes research is that, for many

sponsors, enrollment programs

should be structured not around the

needs of natural savers, namely

Planners and Doers, but around the

needs of Avoiders. Communications

should be even more focused on

communicating current benefits

and simplifying terminology, with

explicit and directive calls-to-action.

• Investment options. Complex invest-

ment menus may be suitable for

Planners, but other segments will

struggle with expanded investment

choice. Both menu design and com-

munications should be adapted to

the needs of an employee popula-

tion’s dominant attitudinal segment.

• Ongoing education. Most ongoing

financial education programs natu-

rally appeal to Planners. Attracting

Secure Doers and Avoiders to

such programs requires a different

approach, with focused efforts

on narrowly targeted and simpli-

fied topics.

• E-communications. Money attitudes

may also be used to devise strategies

for financial websites (both intranet

and Internet) and other e-commu-

nications (including interactive

e-mail, CD-ROMs, and e-meetings).

Among Vanguard participants, 85%

have access to the Internet at work,

at home, or both. As a result, nei-

ther availability nor access is the

chief obstacles to the use of e-com-

munications. Rather it is participants’

underlying interest in personal

finance—in other words, their

money attitude.

Money attitudes also play a role

in the use of new personalized

communications, and in devising a

strategy for offering investment

advice to participants. Additional

details on the use of money attitudes

can be found in a separate publica-

tion from the Vanguard Center

for Retirement Research.51


51 Vanguard, 2002b.

Stock market volatility over the past

two years has raised concerns about

participants’ willingness to maintain

equity-oriented retirement portfolios

in the face of falling stock prices. As

we noted previously (see page 47),

despite this worry, the vast majority

of participants have made no changes

in their investment portfolios in the

past year. Part of the reason has to be

the balancing effect of new contribu-

tions, which for the typical partici-

pant have offset losses from declining

equity investments over the past

two years.

Nonetheless, while the majority of

participants have stayed the course in

their retirement plans, a small group

of participants does make changes in

any given year, and the amount of

money exchanged is meaningful (see

page 48). In this section we review

longer-term data on trading behavior

patterns from Vanguard recordkeep-

ing systems between 1997 and 2002.

We look at the movement (exchange)

of existing monies among investment

options within a retirement plan, and

examine the volume of trading activi-

ty, as well as the direction toward, or

away from, equity holdings.

Our analysis indicates that since the

collapse of the stock market bubble in

early 2000, participant trading vol-

umes have fallen by half. The direc-

tion of money movement—either into

or out of equities—has varied over the

years, fluctuating modestly with then-

current market conditions. But in

2001 the movement to fixed income

investments became more pro-

nounced. Overall it appears that while

fewer participants are making invest-

ment exchanges in their accounts,

those who are trading are favoring

fixed income investments over stocks.

Not surprisingly, the largest outflow

into fixed income investments during

2001 occurred in September after the

terrorist attacks and the temporary

closing of the stock exchanges.


Participant Trading Behavior:A Longer-Term View

Frequency of trading

Few participants trade in any given

year (see chart 88). From 1997 to

1999, 17% of participants made one

or more investment exchanges during

the calendar year. In 2000 that level

rose slightly to 18%, and then in

2001 it fell to 14%.

This data suggests that the typical

participant does not actively make

investment changes in a given year.

It also suggests that the typical

participant does not engage in annual

rebalancing of his or her portfolio.

This low involvement level seems

appropriate in light of the fact that

the typical participant holds only

three investment options with a

median balance of approximately

$15,000. For the typical employee,

a low level of involvement seems

broadly consistent with the modest

account balances and small number

of holdings involved.

Trading volumes

The trading level within retirement

plans has varied considerably over the

past five years. Trading activity,

whether measured in assets or in

terms of number of transactions,

peaked in January 2000, a few months

before the U.S. equity market peak in

March 2000 (see chart 89). Since this

peak in activity in the first quarter of

2000, trading activity volumes have

fallen to half their level.


88. Frequency of Trading

Percentage of Participants Completing an Investment Exchange in Year

17%

14%

18%17%17%

1997 1998 1999 20012000


0%

5%

10%

15%

20%

25%

89. Trading Activity (July 1997–June 2002)

Index Value (July 1997=100)

Percentage of assets traded

Number of trades

7/1997

7/1998

7/1999

7/2000

7/2001

6/2002


0

50

100

150

200

250

300

Trading activity also appears to be

linked to periods of financial turmoil.

The first two peaks in trading activity

coincided with the Asian financial

crisis in 1997 and the Russian debt

crisis in 1998, both of which

increased volatility in U.S. stock mar-

kets. But these bursts in trading activ-

ity were modest compared with sub-

sequent jumps in trading activity in

1999 and 2000.

Although there appears to be a broad

relationship between stock market

levels and participant trading, with

both peaking in early 2001, the link is

more graphical than statistical. We

analyzed the statistical relationship

between trading activity (both assets

and numbers of trades) and various

stock market indexes, including the

Dow Jones Industrial Average, the

Standard & Poor’s 500 Index, and

the Nasdaq market index. In none

of these cases was there a statistically

significant link between trading activ-

ity and the total return on the index.

Further research is needed in this

area, but the graphical data nonethe-

less suggests some type of relationship.

One possibility is that participants

may overreact during periods of

financial crisis or exuberance; but

during other periods, their trading

decisions may be random, and more

related to personal financial decisions

than market conditions.

Direction of money movement

Another way to view participant

trading activity is to analyze the

direction of the monies being

moved—either as a net movement

into equities or a net movement into

fixed income. Over the past five

years, the most remarkable feature

has been the large flow into common

stocks at the peak of the U.S. stock

market in early 2000, and a move,

albeit somewhat erratic, into fixed

income investments during the

recent bear market (see chart 90).


90. Net Money Movement (July 1997–June 2002)

Equity Flows as Percentage of Average Assets


–1.00%

–0.80%

–0.60%

–0.40%

–0.20%

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

7/1997

7/1998

7/1999

7/2000

7/2001

6/2002

Net movement into fixed income

Net movement into equities

Cumulatively, since U.S. stock prices

began to decline in March 2000,

there has been a decrease in trading

activity—but among those trading,

there also has been a shift in senti-

ment (see chart 91). In 1999 there

was an actual net flow out of equities,

representing 0.9% of average record-

keeping assets. In 2000, especially as

a result of the substantial shift into

stocks in the first quarter, there was a

net flow into equities, again equiva-

lent to 0.9% of average recordkeeping

assets. But by 2001 trading activity

had fallen, and those trading had

become more interested in fixed

income investments. Net exchanges

flowed into fixed income investments,

representing 2.5% of average record-

keeping assets.

Implications

Although more research is needed,

these results suggest a few tentative

conclusions. First, the typical (median)

participant makes no investment

exchanges in a given year. Active

involvement with DC plan assets

is relatively uncommon. This low

level of engagement seems consistent

when the typical participant owns

$15,000 in assets and has three

investment holdings.

Second, there appears to be some

link between participant trading

activity and market levels, with trad-

ing spiking at various periods of

market exuberance or decline. But

simple tests between trading activity

and market returns show no statisti-

cally significant link. There is possibly

a more complex relationship between

stock market performance and

participant trading.

And finally, prior to the peak in

U.S. stock prices in early 2000, net

flows to or from stocks seemed to

vary both positively and negatively.

But since the downturn in U.S.

stocks, the direction of trading,

among those who actually do trade,

has been away from common stocks

and into fixed income investments,

particularly in 2001. Yet in aggregate,

participant holdings of equities have

only declined modestly, as new con-

tributions to stocks offset declining

asset values and exchanges into fixed

income investments.


91. Trading Summary (1999–2001)

(In Billions)

% of ParticipantsTrading (Making

an Exchange)Year

Net Flow Into(Out Of)Equities

Net Flow As % of Average

Recordkeeping Assets

1999

2000

2001

0.90%

0.90%

2.50%

(0.9)

1.1

(2.9)

17%

18%

14%


Methodology

The Vanguard data included in this

report is drawn from several sources:

All defined contribution clients. This

universe consists of more than 2,100

plans, 1,400 clients, and 2.5 million

participants for which Vanguard pro-

vides recordkeeping services. It

includes 401(k) and 403(b) plans;

paired 401(k)/profit-sharing plans;

paired 401(k)/ESOP plans; and other

defined contribution arrangements

such as money purchase plans.

Approximately 7 out of 10 Vanguard

client relationships are plans with a

401(k) salary deferral feature. All

references to “The Vanguard Group”

are to this universe, and all data is

as of December 31, 2001, unless

otherwise noted.

Vanguard participation and deferral

rates. Data on participation and defer-

ral rates is drawn from a subset of

Vanguard’s recordkeeping clients

for whom we perform nondiscrimina-

tion testing. This subset includes

more than 650 plans and more than

500,000 participants. Ninety-seven

percent of these plans are 401(k)

or paired 401(k) plans. Income data

used in participation and deferral rate

analyses also comes from this subset

of plans.

External income data. Income data for

asset allocation, account balance, and

loan demographics is from an external

source overlaid onto Vanguard partic-

ipant data. This external income data

covers 65% of the Vanguard partici-

pant universe and is the most recent

data available.

Access channels/Internet data. Data for

access method frequency and demo-

graphics is drawn from a subset of

Vanguard’s universe. The analysis is

based on unique Social Security num-

bers and participants who have been

in their plan for an entire year.

This set covers approximately two-

thirds of all Vanguard recordkeeping

participants. Data on participants’

ability to access the Internet comes

from the Vanguard 2001 Participant

Relationship Study, a biennial tele-

phone survey among a random sam-

ple of 1,000 participants drawn from

Vanguard’s participant base; the sur-

vey was conducted in May and June

2001. Data for reasons participants

visit Vanguard.com is the average

daily number of visits to Vanguard

webpages from January through

April 2002.

Company stock data. Data on restric-

tions on company stock is drawn

from a subset of Vanguard’s record-

keeping universe. It consists of all

tax-qualified plans at Vanguard offer-

ing company stock as an investment

option as of June 30, 2001. The sub-

set covers 264 plans, 173 clients, and

1.2 million participants.

Education and advice data. Data

on participant education needs

and additional interests come from

the Vanguard 2001 Participant

Relationship Study, a biennial tele-

phone survey among a random

sample of 1,000 participants drawn

from Vanguard’s participant base;

the survey was conducted in May

and June 2001.

Finally, this report includes data

drawn from a wide range of industry

and academic sources. Each study has

its unique data limitations and we

encourage you to consult the individ-

ual references listed at the back of

this report.

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Acknowledgments

We extend our thanks to the following

Vanguard crew members who made

this publication possible:

Data analysis

Kathleen Callan

Michael Gold

Gary Mottola

Daniel Proctor

William Nessmith

Communications

Samuel Atlee

Suzanne Cionci

John Friel

Susan Fuhs

Christine M. Johnson

Martha Witte

Stephen Utkus

Vanguard Center for Retirement

Research

®

®

Institutional Investor Group Vanguard Center for Retirement Research Post Office Box 2900Valley Forge, PA 19482-2900

© 2002 The Vanguard Group, Inc.All rights reserved.Vanguard MarketingCorporation, Distributor.

27569-1 092002

[email protected]

On the WebGo to institutional.vanguard.comand select “Vanguard Center forRetirement Research.”

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The Vanguard Group, Vanguard,Vanguard.com, and the ship logo aretrademarks of The Vanguard Group,Inc. All other marks are the exclusiveproperty of their respective owners.

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