(The writer is a Reuters columnist. The opinions expressed are
By Mark Miller
CHICAGO, March 27 Millennials don't seem to buy
the traditional wisdom when it comes to investing. They're the
most risk-averse investors since the Great Depression, with the
average portfolio 52 percent in cash, according to a recent
report by UBS Wealth Management Americas.
That runs counter to what most investment experts will tell
you - that young people need the greatest exposure to riskier
stocks to meet long-range goals, and that equity allocations
should decline as retirement approaches. That philosophy
underpins the fastest-growing retirement savings product in the
market today, the target date fund (TDF).
TDFs automatically adjust your risk exposure to your age
bracket, and they are growing explosively: Some $618 billion was
invested in TDFs at the end of 2013, up from $160 billion in
2008, according to the Investment Company Institute. Most of
that was in defined-contribution plans, which held $5.9 trillion
Rob Arnott thinks the TDFs have it all wrong. A respected
investor and academic researcher, Arnott is chief executive
officer of investment management firm Research Affiliates in
Newport Beach, California. In a recent paper he co-authored in
the Journal of Retirement, he found that investors come out
ahead by starting conservative and taking more risk as they age.
The paper analyzed more than 140 years of historical
returns, simulating hundreds of outcomes over three portfolio
strategies. One begins 80-20, stocks to bonds; the second
rebalances annually to a 50-50 allocation; the third starts with
20-80, stocks to bonds, and moves to an 80-20 equity-centric
allocation over time. Arnott and his co-authors conclude that an
investment of $1,000 over 40 years finishes an average of 11
percent better in a balanced fund than in a TDF; the inverse
glide path beats the TDF by 22 percent.
One of Arnott's key points is that retirees with low equity
allocations miss out on stock market rallies in the out years
when they are older and have the largest portfolios and hence
the largest potential gain. But I asked Arnott recently about
high equity allocations for young people after seeing some
eye-popping data pointing to a fundamental problem with the
assumption that young investors can take the long view with
Fidelity Investments reported recently that 41 percent of
workplace retirement savers in their 20s cashed out their
accounts when they left their jobs. Cash-outs before age 59 1/2
are subject to a 10 percent penalty in most cases, and the funds
are taxed as ordinary income in the year of withdrawal.
Most important, the Fidelity numbers suggest that for many
young workers, retirement accounts aren't "long view" money.
Twenty-five percent of all 401(k) accounts are terminated after
three years, according to Federal Reserve data, and 50 percent
are gone after seven years. Some of those are rolled over, but
many are cashed out.
"If young adults early in process of saving are that
skittish about risk, why put them into something that is 80
percent stocks, where they could suffer huge losses if we have a
repeat of 2008 and 2009," Arnott says. "Half of their liquid
wealth could disappear, and they'll shun risk for the rest of
"Having their early money invested in a less aggressive
fashion would make this feel more like a savings plan than a
speculative coin toss. If it feels more like a savings plan,
they might have more desire to stay with it, rather than cashing
out when they change jobs."
Arnott suggests starting young people in a beginner's
portfolio with broad diversification and much less risk. "I'd
structure it so you have very low volatility and can never lose
more than 20 percent of your principal. Keep it there until you
have maybe $50,000, and then move it into a target date fund."
Most experts draw a different lesson from the cash-out
figures - that young people should be encouraged to build up
emergency funds outside their 401(k)s that will help them avoid
tapping retirement accounts when they hit a rough patch or
"It's troubling to see people taking out funds instead of
rolling them over or keeping it in the plan," says Wei Hu, vice
president of financial research at Financial Engines, which
provides financial planning services to employees enrolled in
workplace plans. "The smart thing to do is make sure you have
enough emergency money available outside of your tax-deferred
account that you can get to quickly and easily and keep it
That sounds good - in theory. But for many younger
households, financial pressures make any saving difficult. Sixty
percent of households participating in a 401(k) plan added more
debt to their family balance sheet than they contributed to
retirement savings from 2010 to 2011, according to a study by
Hello Wallet, another workplace financial guidance firm.
Most investment managers reject Arnott's view that equity
exposure should begin low and increase as retirement approaches.
And Jerome A. Clark, portfolio manager of the T. Rowe Price
Retirement Funds, adds that constructing retirement investment
products around less-than-perfect investor behavior wouldn't
"With any retirement product, you're trying to solve a
specific problem. With TDFs, the problem is how to accumulate
savings in an appropriate way, and then provide lifetime income
in retirement. We know there will be a wide range of behaviors
by investors in a plan - and that there will be suboptimal
behavior. But for most plan sponsors, it's about providing an
asset allocation that gives people the best chance of meeting
For more from Mark Miller, see link.reuters.com/qyk97s
(Follow us @ReutersMoney or here.
Editing by Douglas Royalty)