The conventional wisdom that says “100 minus your age” indicates how much of your portfolio should be stocks, with the remainder going to bonds, forces the young to gamble away their safety net and exposes retirees to the ravages of inflation.
That is the surprising upshot of the latest investor newsletter from Research Affiliates, authored by firm founder Rob Arnott together with researcher Lillian Wu.
Arnott, whose dozens of mostly equity-based indexes attest to a generally stock-friendly disposition, confines his allocation argument to advice conventionally proffered by the rapidly growing $650 billion target-date fund (TDF) industry.
Critics have noted that target-date funds are heavily allocated toward equities, and indeed the average stock allocation for an investor 25 years out from retirement is 70% or more.
Since target-date funds serve as a government-sanctioned default choice for 401(k) investors, the portfolios of younger workers are increasingly invested according to a glide path, according to which younger employees own equity-based portfolios that only slowly shift to bonds as they age.
But Arnott and Wu lament that this approach is “allergic to arithmetic and empirical testing.”
Specifically, they cite a Fidelity study from earlier this year of 12.5 million retirement plan participants showing that a whopping 41% of investors between the ages of 20 and 39 cash out some or all of their assets when switching jobs.
Younger workers are thus exposed to a “triple-whammy” of raiding their savings to meet basic living expenses; selling when their assets may be valued at less than the amount they invested; and having to pay the IRS a stiff penalty for their withdrawal.
The authors cite additional data showing that younger workers are far more vulnerable than older workers to bouts of unemployment — with workers in their 20s suffering an unemployment rate over double that of workers 45 or older over the past quarter century, for example.
Recessions exacerbate this problem, with younger workers experiencing unemployment increases at a rate 60% higher than older co-workers.
Since stock market declines typically precede recessions, “young investors’ equity-heavy TDF investments plunge just when they’re more likely to be laid off, and/or just before they cash in their DC fund!” the authors write.
Because of this reality, Arnott and Wu reject what they consider the ill-founded assertion by finance academics that “human capital is like a bond” so that we should replenish our diminishing human capital with bonds as we age.
“Pardon me, but doesn’t employment income feel more like equities … with ever-rising uncertainty the farther we look into the future?” the authors ask.