In “What Are We Doing to Our Young Investors?” Rob Arnott,
CEO of Research Affiliates, and Lillian Wu, co-author of the report, suggest
that since younger workers sometimes treat their retirement accounts as rainy
day funds, they should be able to put some savings into an account
separate from a 401(k) or other retirement plan that could be accessed to
meet emergency needs without penalties.
One reason is the timing of the investor’s entry into the
market can be a critical factor in how the investor comes to view savings and
the market, Wu explains. People are very sensitive to experience, such as the
market crash of 2008-09. If investors happen to begin their portfolios during a
bull market, the portfolio will go up.
Another reason for the idea of an account separate from a
retirement plan is that target-date funds (TDFs) used by these plans start
these youngest employees with a heavy allocation to equities with the
expectation that they will shift into bonds later on. But, if they lose their
jobs in a bear market and decide to cash out, it can be a triple whammy if the
retirement plan is their only savings. They may have to cash out to meet basic
living expenses, and the assets invested may actually be less than what was set
aside from their paychecks. In addition, they must pay stiff penalties for the
early withdrawals.
Because a young adult’s job security is highly correlated
with the business cycle, younger workers endure higher rates of unemployment,
higher job turnover and longer-lasting unemployment. For this reason, it’s
possible that younger savers are less suited to the higher-risk profile than
older ones.
In addition, a high allocation to equities may not be
suitable because younger investors have different investor behaviors and
reasons for savings. They save for a precautionary purpose, for rainy days and
short-term emergencies.
While they are advocates of workplace-based saving for
retirement, Arnott and Wu contend that a second investment vehicle is needed to
meet the specific needs of younger workers, and they recommend features that
would address several concerns. First, the account would provide a range of
asset classes—not just stocks and bonds but exposure to real estate investment
trusts (REITs), commodities, emerging markets in both equities and bonds and
some high-yield debt. The mix could be close to 60/40 and it should be
resilient through a range of market conditions.
Having a more stable non-401(k) solution could be ideal but
a product that resembles the target-date fund (TDF) is likely not the answer.
If the idea gains traction, there would need to be some product innovation by
providers, and plan sponsors might have some opportunities to consider
different types of portfolios for different types of investors.
A change in mindset of younger savers and investors might be
necessary. Although their finances can be tight, right now they have no other
workplace option than auto enrollment into a 401(k) plan. A more flexible,
low-risk portfolio could add a layer of comfort.
Of course, the ideal situation is for borrowers at any age
not to tap into their retirement plans until they reach retirement age. If
awareness among all savers could be heightened to make them see the importance
of saving for retirement. Until then, it may be realistic to create some
savings vehicle that speaks to the savings behaviors and financial realities of
younger workers.
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