Perspectives : Investment | October 15, 2024

Out of sight, out of market: The IRA cash drag

Vanguard’s research on the cash drag in IRA accounts revealed a costly error that many Americans make when saving for retirement: letting rollover assets from 401(k) plans languish in cash for months or even years. Why do they do this? Our recent survey of Vanguard rollover investors indicates that it tends to be an error of omission rather than commission: They are twice as likely to hold cash unintentionally as they are to do so deliberately.

Why investors stay in cash

We tested a wide range of explanations for why investors stay in cash following a rollover, including intentional reasons, such as risk aversion, and unintentional factors, which might include procrastination or a lack of awareness.

Awareness proved to be the biggest issue: Two-thirds of respondents who stayed in cash following a rollover didn’t know how their IRA assets were allocated. Only one-third said it was intentional and that they preferred holding cash.

IRA cash is a billion-dollar blind spot,” said Andy Reed, head of investor behavior research at Vanguard. “Many IRA holders want to invest their retirement savings in the stock market and think that they’re invested following a rollover. In reality, they’re sitting in money market funds.”

Common reasons why IRA rollover investors stay in cash

A bar graph shows explanations for why IRA holders stayed in cash after rolling over their 401(k) assets. The reasons and accompanying percentages of respondents are: “Do not realize how their assets are invested” at 68%, “Believe IRA contributions are automatically invested” at 48%, “Prefer a cash-like investment” at 35%, “Feel overwhelmed by the number of IRA investment options” at 27%, and “Never got around to investing it” at 15%.

Note: Because survey respondents could report more than one reason, the cumulative percentage of the reasons given exceeds 100%.

Source: A Vanguard survey of 556 investors who completed a rollover to a Vanguard IRA in 2023 and left those assets in a money market fund through June 2024. 

IRA misconceptions are common

Our survey shows that rollover investors who stayed in cash demonstrated high levels of investing knowledge and experience:

  • 77% of respondents knew that mutual funds tend to be less risky than individual stocks.
  • 71% knew that money markets are a conservative investment.
  • 77% owned investment accounts prior to rolling over their 401(k) assets.

And yet close to 50% of those investors mistakenly believed that IRA contributions were automatically invested and 46% did not realize their contributions were allocated to money market funds by default.

“Investors who are used to their 401(k) assets being automatically invested in target-date funds may believe that IRAs work the same way,” said Ariana Abousaeedi, a Vanguard investment strategy analyst who conducted the survey. “But there is no default investment like in 401(k) plans—money in IRAs requires active engagement to get invested.”

IRA investment choices can be overwhelming, but help exists

While 401(k) plans typically offer a limited menu of funds handpicked by plan sponsors, IRAs offer thousands of choices among funds, individual stocks, bonds, certificates of deposit, and other asset classes. That plethora of choices can be unwelcome: One in four rollover cash investors reported feeling overwhelmed by the number of options. When asked how many options they ideally want to have in their IRA, the median response was 10.

“Choice overload is a real risk for IRA investors,” said Nathan Zahm, head of client experience alpha at Vanguard. “Easing the mental burden by curating options or offering advice can be a big help to investors who might otherwise stay in cash forever. Better yet, a policy change allowing target-date funds to be a default option could solve this problem at scale.”

Closing the gap between perception and reality

Many investors who have dutifully saved for their retirement in the workplace are unaware that their rollover assets are sitting in cash. This could result in missed opportunities to earn investment returns and even lead to painful shortfalls in retirement.

An easy fix: Take a close look at your portfolio to ensure it’s allocated in a way that makes sense for your long-term plans. What you find may come as a surprise.

Contributors

Andy Reed, Ph.D.
Vanguard Head of Investor Behavior Research

Ariana Abousaeedi, CFA
Vanguard Investment Strategy Analyst

Nathan Zahm
Vanguard Head of Client Experience Alpha

Fiona Greig, Ph.D.
Vanguard Global Head of Investor Research and Policy

Aaron Goodman, Ph.D. 
Vanguard Investment Strategist

Note:

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