Should young retirement savers load up on stocks? Maybe not

Rob Arnott, Research Affiliates

Rob Arnott, Research Affiliates

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 last year.

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 their money.

Fidelity Investments reported recently that 41 percent of workplace retirement savers in their 20s cashed out their accounts when they left their jobs. The numbers suggest that for many young workers, retirement accounts aren’t “long view” money at all. Learn what Arnott had to say about the implications at Reuters Money.