The Cost of Miscalculating Investment Risk-Taking

I invested in my first mutual fund when I was in my 20s. It was a balanced fund, with 40 percent in fixed income.

Why did I invest so much in fixed income when I was that young, knowing I was saving for the long term? I was an inexperienced investor at that time. Further, Black Monday was fresh in my mind — with the Dow Jones Industrial Average dropping 22.6 percent in one day in 1987. This led me to conclude that it was best to start out conservative — without realizing how much upside I might sacrifice over a long time horizon.

It turns out that even today, some young people are still prone to favoring heavy fixed income allocations in their retirement portfolios. According to new findings from EBRI and NAGDCA’s Public Retirement Research Lab (PRRL), the typical state of California government worker aged 25 to 34 has more than a third of their defined contribution (DC) assets in short-term fixed income and stable-value funds. This contrasts with typical target-date fund allocations of just over 10 percent in fixed income for those with 30- to 40-year time horizons.

Of course, 25- to 34-year-old Californian public DC plan investors may feel good about limiting their exposure to the stock market given recent volatility. But the fact remains that stocks outperformed short-term bonds in almost 90 percent of the 10-year periods since I started investing, and the average annual outperformance of stocks over short-term fixed income for that full time period was nearly 10 percentage points.

Interestingly, when we look at how 25- to 34-year-old public DC plan employees are invested across the rest of the country, we find that the short-term fixed-income and stable-value allocations are much lower. Instead, for these investors, target-date funds are the most prevalent allocation — with an average allocation of 74 percent among the youngest demographic nationwide (excluding California).

Of course, sponsors of government plans may take the position that because many government workers will ultimately have defined benefit plan income at their disposal in retirement, there is less need for these workers to assume stock-market risk within their defined contribution plans. As such, conservative investing by young government workers shouldn’t be considered a problem. On the other hand, the presence of a defined benefit annuity to provide secure income in retirement might give participants freedom to take on more risk in their defined contribution accounts. And further, leaving money on the table is rarely an ideal investment strategy.

About ebriorg
President and CEO, EBRI

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