IRA Insights: Do contribution deadlines lead to poor investment decisions?
February 06, 2014
Nearly four out of every ten U.S. households own an IRA, holding more than $5.7 trillion in these accounts, according to a 2013 study by the Investment Company Institute. Because of the significant role they play in retirement savings, researchers from Vanguard's Investment Strategy Group set out to understand Vanguard investors' behavior when it came to IRAs. Are they saving effectively? Investing prudently for their futures?
Our researchers are sharing their findings in a new series called IRA Insights. The first installment appears below, or you can download a copy.
The percentage of IRA contributions allocated to money market funds increases between January and April. During "tax season," investors are under time constraints to make their IRA contribution for the prior year. Although they know they need to make the contribution, they haven't necessarily made their investment choice. As a result of decoupling the contribution and investment decision, many investors in this situation choose a money market fund as a "parking lot."
Percentage of IRA contributions made to money market funds:
More than two-thirds of last-minute contributions made to money market funds remained in money markets four months later. But what seems like a prudent temporary decision can become an ill-advised longer-term investment choice.
Money market contributions for tax year 2012 made in April 2013:
IRA investors could benefit from mirroring the plan sponsor trend toward increasingly making target-date funds their default option for participants. Balanced funds, such as target-date funds, offer many advantages. They are low-cost, diversified, professionally managed funds that provide a convenient way to save for retirement. The asset allocation management embedded within balanced funds can also help investors avoid behavioral challenges such as inertia, market timing, portfolio concentration, and failure to rebalance.
Default fund options for Vanguard defined contribution plans:
Reference: Utkus, Stephen P., and Jean A. Young, 2013. How America Saves 2013: A Report on Vanguard 2012 Defined Contribution Plan Data. Valley Forge, Pa.: The Vanguard Group.
- All investing is subject to risk, including the possible loss of the money you invest.
- Diversification does not ensure a profit or protect against a loss.
- Investments in Target Retirement Funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in the Target Retirement Fund is not guaranteed at any time, including on or after the target date.
- An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.
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