Investors are typically overweight equities and gradually scale back their stock exposure as they hit their golden years. However, some argue that young investors should not be over-allocated toward stocks either.
In a recent research note, Rob Arnott, the chairman and CEO of Research Affiliates, believes that stock-heavy portfolios, such as target-date funds aimed at young investors, are a bad fit for 20-something workers since people could tap out their retirement savings if the economy moves into a recession, reports Karen Damato for the Wall Street Journal.
Target-date funds track a mix of stocks, bonds and other investments. The funds will typically overweight stocks for young investors and become more conservative, or overweight fixed-income assets, when they move toward retirement age.
For instance, the Deutsche X-trackers 2020 Target Date ETF (NYSEArca: TDH) has a 46.3% stock allocation and a 53.2% bond position, whereas the Deutsche X-trackers 2040 Target Date ETF (NYSEArca: TDV) includes 90.8% stocks and 8.8% bonds.
BlackRock’s iShares had a group of Target Date ETFs, but trading in the funds were halted prior to market open on October 15, 2014. [iShares Will Close 18 ETFs]
People typically overspend when they are young and aggressively save as they approach their peak earning years.
“Many young adults are establishing their financial self-reliance, starting families, and saving down-payment money for their first homes, often while burdened with student loans,” Arnott writes.
Additionally, Arnott believes that young workers are more likely to lose their jobs in a recession and would not have enough savings outside their paychecks. Between 1990 to mid-2014, workers between the ages of 20 and 24 experienced an average unemployment rate of 10%, compared to those ages 25 to 34 and 35 to 44 with jobless rates of 6% and 5%, respectively.
Consequently, young investors should begin thinking about the level of risk they are comfortable with.
“If young workers have to deal with their volatile young human capital over a long horizon – with a heightened need to cash out when the portfolio values are depressed – then it makes even more sense for young workers to begin with a less risky portfolio,” Arnott added. [Value Drives This Smart Beta ETF]
For more information on investing toward retirement, visit our retirement category.
Max Chen contributed to this article.