Workers’ investment choices, along with their contributions, determine how much wealth they will have in their defined contribution (DC) plans when they retire. Sound asset allocations help grow assets and manage risks, both of which are crucial as more retirees rely on their DC plans to see them through retirement. Roughly 58% of all U.S. retirement assets are in DC-type accounts.1

This analysis examines the salient patterns of workers’ asset allocations in retirement accounts using the Survey of Consumer Finances (SCF, 2004, 2007, 2010 and 2013 waves). It combines all DC-type accounts from current and prior jobs for each household and calculates the value-weighted percentage invested in equity. Individual retirement accounts (IRAs) are disregarded, as our focus is on plans more likely to be directly influenced by employer-sponsored plan design and governance. In the main text, we tabulate asset allocations by various economic and demographic groupings. The Appendix provides a more technical regression analysis that identifies influences while controlling for many factors simultaneously.

Asset allocations at the extremes

In a significant number of American households, DC allocations occupy the extremes — about 15% of these investors shy away from equities entirely, while roughly 22% invest everything in equities (Figure 1). Avoiding equity entirely forgoes opportunities for higher returns, thus slowing retirement wealth accumulation. Investing everything in equities, however, poses the risk of major losses, which would fall particularly hard on DC-only workers.

Figure 1. Range of equity allocations in DC accounts (%)
Figure 1. Range of equity allocations in DC accounts (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

The extent of extreme investing declined from 2004 to 2013 (Figure 2), suggesting that households are better diversifying their retirement portfolios. Qualified default investment alternatives (QDIAs) presumably have attracted more workers into the equity market.2 Meanwhile, the financial crisis of 2008 provided a lesson in investing, as plan participants watched their asset values suddenly tumble. Those who managed to avoid panic selling have likely recovered their losses by now. Still, excessive equity exposure is not wise investing. The most desirable asset allocation for any person or household should reflect many factors, prominently including risk tolerance, economic situation, retirement plan provisions and other demographic attributes.

Figure 2. Equity exposure in DC accounts over time (%)
Figure 2. Equity exposure in DC accounts over time (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Asset allocations by demographics

Age

Equity exposure declines as workers age. Equity market participation (non-zero in equity) is highest among investors in their 30s through 50s (Figure 3). Roughly 37% of 25-to-34-year-old investors hold 75% or more of their savings in equities, compared with about 26% of 65-to-74-year-olds. This link between risk reduction and age is basically consistent with life-cycle financial advice, which encourages investors to allocate a larger share of assets to equities when they’re young and then reduce the equity allocation as they age. Human capital (expected future earnings) is generally considered bond-like, thereby offsetting the risk associated with equities for younger workers, with the risk offset declining gradually over their careers.

Figure 3. Equity exposure in DC accounts (%) by age
Figure 3. Equity exposure in DC accounts (%) by age

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Target date funds (TDFs) — a QDIA — have become increasingly popular in recent years. The percentage of DC plan sponsors with TDFs as the default investment option increased from 64% in 2007 to 86% in 2014.3 TDFs start out with greater equity holdings and then automatically reduce equity allocations as participants near retirement.

Among age 55 – 64 households, the median equity allocation was around 50% from 2004 through 2013 (Figure 4). This falls in the middle of the TDF glide paths established by major fund providers.4 A further breakdown of equity allocations, however, reveals that more than 20% of these older DC plan participants are fully invested in equity (Figure 3). These households are particularly vulnerable to market risks because they are approaching the end of their careers. Should they suffer big investment losses, postponing retirement might be an option, but likely a painful one, absent other sources of retirement income, such as defined benefit (DB) pension plans.

Figure 4. Equity allocations in DC accounts for age 55 – 64 households over time (%)
Figure 4. Equity allocations in DC accounts for age 55 – 64 households over time (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Risk tolerance

The equity share of a retirement account is correlated with the investor’s risk preferences. Households willing to take on greater financial risks in exchange for potentially greater returns tend to invest more heavily in equities, compared with more risk-averse investors (Figure 5).

Figure 5. Median and average equity allocations in DC accounts (%) by risk preference
Figure 5. Median and average equity allocations in DC accounts (%) by risk preference

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Researchers and financial advisors generally consider risk tolerance a key factor in determining optimal equity exposure. In some cases, however, self-assessed risk tolerance alone appears to have a weak relationship with actual equity allocations. Almost 31% of workers who identify their risk tolerance as average and almost 25% who claim to be unwilling to take risk hold 75% or more in equity (Figure 6).

Figure 6. Range of equity allocations in DC accounts by risk preference (%)

Figure 6. Range of equity allocations in DC accounts by risk preference (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Education

Better-educated households are more likely to invest in equities: Fewer have zero equity and more allocate larger shares of assets to equity (Figures 7 and 8). More years of education likely indicate better financial literacy, which suggests that financial education — assuming it is carefully designed and well-targeted — can influence households’ portfolio selections. Also, workers with more education typically have higher incomes and net worth, which serve as a buffer against market shocks and thus allow more leeway for risk taking in their portfolios.

Figure 7. Median and average equity allocations in DC accounts by education level (%)
Figure 7. Median and average equity allocations in DC accounts by education level (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Figure 8. Range of equity allocations in DC accounts by education level (%)
Figure 8. Range of equity allocations in DC accounts by education level (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Financial planning horizon

Households with longer financial planning horizons often invest more in stocks (Figures 9 and 10). These households are presumably hoping to capture the equity risk premium and can better tolerate short-term volatility. So it is puzzling that a significant number (21%) of investors whose planning horizon extends only to the “next few months” hold their assets entirely in equities. This is risky, too, unless they have considerable other wealth or income, or they’re not planning to draw down DC assets for a long time.

Figure 9. Median and average equity allocations in DC accounts by financial planning horizon (%)
Figure 9. Median and average equity allocations in DC accounts by financial planning horizon (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Figure 10. Range of equity allocations in DC accounts by financial planning horizon (%)
Figure 10. Range of equity allocations of DC accounts by financial planning horizon (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Asset allocations by household wealth and income

Net worth

Wealth levels strongly influence portfolio allocations. Households with greater total net worth (including housing wealth but excluding Social Security) invest more in equities on average (Figure 11). Nearly 45% of households whose net worth is at least $5 million allocate 75% or more of their account balances to equity versus 32% of those with less than $50,000 (Figure 12).

Figure 11. Median and average equity allocations in DC accounts by net worth (%)
Figure 11. Median and average equity allocations in DC accounts by net worth (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Figure 12. Range of equity allocations in DC accounts by net worth (%)
Figure 12. Range of equity allocations in DC accounts by net worth (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Wealth composition (DB coverage)

The effects of DB pension coverage and wealth are mixed (Figures 13 and 14). Households with DB coverage are more likely to hold equities; a smaller percentage of them invest entirely in bond-like assets than those without a DB plan. This is largely rational, given the leverage of the guaranteed DB payouts, which provide a steady flow of fixed income. However, overall equity allocations do not linearly increase with DB wealth level. More notable — and also a concern — is that about 22% of households without DB coverage invest entirely in equities.

Figure 13. Median and average equity allocations in DC accounts by DB wealth (%)
Figure 13. Median and average equity allocations in DC accounts by DB wealth (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Figure 14. Range of equity allocations in DC accounts by DB wealth (%)
Figure 14. Range of equity allocations in DC accounts by DB wealth (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Income

Household income significantly affects equity market participation and the equity share of the retirement portfolio, with higher-income households more likely to invest in equities (Figures 15 and 16).

Figure 15. Median and average equity allocations in DC accounts by household income (%)
Figure 15. Median and average equity allocations in DC accounts by household income (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Figure 16. Range of equity allocations in DC accounts by household income (%)
Figure 16. Range of equity allocations in DC accounts by household income (%) 

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Asset allocations by plan provisions

Investment options

The equity share of DC accounts is generally larger when participants are aware of investment options and are able to choose their own investments (Figure 17). Nearly 33% of households with no control over their investment selections have no equity investments (not shown in Figure 17). Plans that don’t allow participants to choose their investments may be more likely to maintain conservative asset portfolios.

Figure 17. Median and average equity allocations in DC accounts by investment choice (%)
Figure 17. Median and average equity allocations in DC accounts by investment choice (%)

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Conclusions

According to our analysis of investment patterns, age, net worth, income, risk tolerance, education and financial planning horizon, as well as the plan’s investment options, all significantly affect how workers invest their DC plan assets. Thirty-seven percent of households hold equity allocations at the extremes — all or nothing. In some cases, workers’ allocations to equity seem contrary to their stated risk preferences.

Workers increasingly rely on their DC plans for a large share of their retirement income and need to make informed decisions based on their preferences, household finances and sound investment principles. Additionally, the design of employer-sponsored programs shapes participants’ asset allocations and thus their wealth trajectories.

Appendix

The data sample in the analysis includes households with at least one member working at the time of the survey. The analysis excludes households whose income is below poverty guidelines in the reporting year (data by the Department of Health and Human Services), because the saving and investment behavior of low-income households might vary considerably with eligibility for government programs.

To eliminate other potential behavioral outliers, observations are dropped if total net worth (including housing wealth, excluding Social Security) is negative, zero or greater than $10 million; household income is greater than $1 million; or wages exceed $500,000. Some assumptions are required to calculate the present value of DB plan wealth. The assumptions include nominal discount rates (equal to real interest rate plus CPI inflation rate) and nominal salary growth rate (equal to real wage growth plus inflation). These rates are identical to the intermediate assumptions in the Social Security Trustees Reports in respective reporting years. Defined benefit wealth is reset to zero if the value is missing in the survey.

Regression analysis: Simultaneously identifying influences on asset allocations in retirement accounts

An econometric regression analysis is enlightening because it disentangles the influences on portfolio selections, controlling for a host of factors simultaneously. The regression runs the dependent variable, the value-weighted equity percentage combining all DC accounts, on factors that potentially explain variations in equity exposure. Since the percentage is between 0 and 100 (i.e., censored at both ends), a Tobit regression specification is appropriate to gauge the coefficients and signs on the explanatory variables. Figure 18 reports the results.

Figure 18. Influences on asset allocations (Tobit regression analysis, equity percentage as dependent variable)
Figure 18. Influences on asset allocations (Tobit regression analysis, equity percentage as dependent variable)

Notes: The sample includes households with at least one member working. IRAs are excluded. The symbols *, ** and *** indicate significance of 10%, 5% and 1%, respectively; insignificant otherwise.

Source: Towers Watson calculations based on Survey of Consumer Finances, 2004 – 2013

Equity investing exhibits a hump shape by age. The equity percentage rises with age, but the increase slows and reverses at older ages, as indicated by the significantly positive coefficient on age and negative coefficient on age squared.

The wealthy tend to invest more in equity. Higher incomes appear to be associated with lower equity allocations, contradictory to the earlier charts. The reason is that net worth and income are highly correlated, leading to the positive relationship with equity allocation being mainly embedded in one factor (wealth). Coefficients on other variables are not sensitive to whether net worth and income are separated in two regressions (models 2 and 3).

The DB share of total retirement savings — a measure of wealth composition — is positively associated with equity allocations. This is consistent with the assumption that workers feel more comfortable investing in equity when they have a greater cushion from the guaranteed DB plan benefit.

A plan’s investment options significantly influence equity allocations. All else being equal, equity allocations are 20 percentage points higher for participants who fully choose their fund line-ups than for those with no control over their investments. This finding indicates that participants’ allocations and financial outcomes significantly hinge on plan design and offerings.

Workers with graduate degrees hold higher equity allocations in their retirement accounts than high school graduates. Risk tolerance matters. Investors who are willing to take on substantial risk in hopes of higher returns hold more in equities, by about 25 percentage points, than those who are more risk averse. A worker’s financial planning horizon also affects his or her investment patterns. Those whose planning horizon exceeds 10 years have a greater equity share — by roughly five percentage points — than those with only a one-year horizon.

Public-sector workers invest less in equity compared with their private-sector counterparts. This probably results from two opposing forces. The public sector typically offers more stable incomes and relatively more generous DB benefits, which should make more room in the risk budget for larger equity shares. Nonetheless, the job security offered by the public sector may attract and retain more risk-averse workers, who tend to invest less in equities, with the latter force appearing to dominate. This pattern also likely applies to union members, who similarly invest more conservatively than non-members. Self-employed workers tend to invest more in equity than regular workers, perhaps because the self-employed have a larger risk appetite.


Endnotes

1. See Towers Watson’s Global Pension Assets Study, 2014.

2. QDIAs were established by the Pension Protection Act of 2006.

3. See Towers Watson’s Ready, Set, Retire: Using Defined Contribution Plans to Improve Retirement Readiness, 2014 Defined Contribution Plan Sponsor Survey Report, U.S.

4. According to Towers Watson’s data collection of 22 TDF providers in 2014, equity allocations ranged from 40% to 70% 10 years before retirement and from 0% to 40% at retirement.