Extreme Asset Allocation Can Hurt Your Retirement At 25 Or At 60

Despite what conventional wisdom might suggest, Millennials and Boomers do, in fact, have something in common.  While they represent opposite ends of the age spectrum, they both share a common retirement investment pitfall – being prone to “extreme allocation” in their 401(k)s.  Extreme allocation occurs when an investor is either substantially over-allocated or under-allocated to equities.

Some Millennials Are Vastly Under-Allocated In Equities

First, T. Rowe Price’s research into millennial investing habits indicates that some young investors in their 20s are vastly under-allocated when it comes to equities at a time when they should have the majority of their assets in equities. They have the benefit of time: They can take a long-term approach and ride out volatile equity markets. Surprisingly, some members of this group couldn’t be farther from their age-appropriate allocation.

We[1] looked at Employee Benefit Research Institute and Investment Company Institute studies[2] of 401(k) participants dating back to 2005, showing that at that time, almost 20% of investors in their 20s had 0% in equities. This number has improved over the years, but remains high, with 10% of investors in their 20s having no equity holdings.

Part of the reason for the improvement in the numbers may be the growth in target-date funds as a default for 401(k) plan participants. Plans that auto-enroll new employees into their 401(k), and use a target-date fund as the investment, are defaulting participants into an age-appropriate asset allocation.

Older Investors Are Also At Risk

Secondly, at the opposite end of the spectrum, we see investors in their 60s who may be entering retirement or have just retired who have too much of their retirement savings in equities.  In 2005, the same study cited above indicated that 33 % of this group had 80% or more of their retirement savings invested in equities.  This may have been appropriate decades earlier, at the time when they likely selected this allocation. But, at this later stage in life and so close to retirement – this allocation may not be appropriate.  Investors in their 60s should consider lowering their equity allocation, potentially to the 40%-60% range – and carefully considering the potential impact of market risk.

Like with the millennials, over the last ten years these numbers have improved but remain high: 25% still have 80% or more of their investments in equities.

“Outlier” Investors Could Be Headed To Less Successful Retirement Investment Incomes

“Outliers,” as they are known, whether millennials or boomers, could unwittingly be headed to much less successful retirement investment outcomes. A millennial investor’s under-allocation to stocks could result in decades of lost growth potential essential to building a robust retirement portfolio in the future, while a boomer investor’s over-allocation to stocks could put their years of retirement savings at risk.

Why is extreme asset allocation still an issue?

So, why is extreme allocation still an issue, given the multitude of educational, product and investment tools available and the great deal of attention and awareness on retirement planning and the importance of diversification? There are several factors at play:

• Procrastination, Inertia or Lack of Awareness: In many instances, retirement investors are not taking the time to regularly monitor their retirement portfolio and better understand the potential investment risks. Investors of all ages need to play an active role in ensuring they are invested in stocks at the appropriate levels.
• Target Date Funds and Auto-enrollment: For the investor in his/her 20s, the advent of target date funds and auto-enrollment features has helped, to some degree, in establishing an age appropriate mix of equities and fixed income products. Given the way that plan design changes have been adopted, many plans have auto-enrolled new and younger employees into a target-date option but may not have reenrolled current participants into an age appropriate target-date option.  Most of the company’s 60-year-olds are likely to fit into this category.

What can you do to avoid extreme allocation? 

Here are some approaches:

• Regularly monitor your retirement portfolio to ensure it has an appropriate mix of stocks, bonds, and short-term investments for your time horizon, risk tolerance, and personal circumstances.
• Consider using a one-step diversified investment option such as a target-date fund

Millennials and Boomers despite their age differences, do, in fact, share a similar vulnerability when it comes to retirement savings.  The reality we all need to be aware of, regardless of age, is that “extreme allocation” in a 401(k) can lead to less successful retirement outcomes.

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The principal value of target-date funds is not guaranteed at any time, including at or after the target date, which is the approximate date when investors plan to retire. These funds typically invest in a broad range of underlying mutual funds that include stocks, bonds, and short-term investments and are subject to the risks of different areas of the market. In addition, the objectives of target-date funds typically change over time to become more conservative.

T. Rowe Price Investment Services, Inc., distributor, T. Rowe Price mutual funds.

[1] With thanks to Maria Gorshkova and Caitlin Sien for their research efforts.

[2] 401(k) Plan Asset Allocation, Account Balances, and Loan Activity, Employee Benefit Research Institute and the Investment Company Institute, Asset allocation distribution of 401(k) participant account balances to equities, by age, percentage of participants, 2005-2013.