It’s regarded as conventional wisdom that young people’s retirement plans should be mostly in stocks when they first start investing.
But some advisors say that’s too risky.
Many millennials will have to rely almost exclusively on what they have in their 401(k) and other workplace retirement plans, so where they invest and what they invest in becomes extremely important, said Rob Arnott, chairman and CEO of Research Affiliates. “If they start out with a balanced portfolio of 30 or 40 percent in equities, 30 or 40 percent in bonds and 30 or 40 percent in liquid alternatives … it will give them broad diversification,” Arnott told CNBC’s “Closing Bell” on Tuesday.
Instead, young investors have been loading up on stocks in their 401(k) plans in recent years. Eighty-five percent of the portfolio of the average 25-year-old is in equities, according to Vanguard, a leading provider of 401(k) plans. A decade ago, stocks only made up a little over half of the portfolios of that age group.
“Time horizon is only one element of risk assessment. It addresses the ability to take risk, but misses the much bigger factor—an investor’s willingness to take risk,” said wealth advisor Tim Maurer, director of personal finance at the BAM Alliance. “I don’t know that I’d go quite so far as to recommend only 40 percent in equities, but I absolutely agree that new investors should be taking less risk at the front end of their investing careers than convention suggests.”
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Most millennial investors are increasingly getting the bulk of their equity exposure through target-date funds, which were the fastest-growing investment for this group last year, according to Strategic Insight. These funds are mostly invested in stocks at the onset, a time when it is thought that investors can bear more volatility and risk. The funds decrease exposure to stocks as the investor gets closer to the target retirement date.
“The key to the success of this strategy is something many investment folks don’t focus on, which is: What other safeguards have you put in place to prepare for the unexpected?” said Manisha Thakor, author of “On My Own Two Feet: A Modern Girl’s Guide to Personal Finance” and a member of the CNBC Digital Financial Advisor Council. “Investing is an activity that should only be undertaken once other core activities have been attended to, like making minimum payments on all debts in a timely fashion and setting aside money for an emergency fund.”
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In addition to weathering the stock market’s ups and downs, many younger investors face other risks—job losses, student loan debt and a lack of emergency savings. According to Fidelity Investments, 44 percent of those in their 20s are cashing out of their 401(k) plans—despite getting hit with early withdrawal penalties and taxes. They’re also losing the benefit of compounding interest. Investing without having emergency cash on hand is another big reason a stock-heavy portfolio can be a riskier investment strategy.