So much is made of young peoples’ inability to handle their money wisely that I thought I’d share some encouraging news. Those who have been in the workforce for just a few years and participate in a 401(k) plan are doing a bang-up job managing their retirement assets, new data show.
Let’s be clear: Not enough young people who are eligible for a plan participate in one, and even those that do participate save only about 5% of their pre-tax income. Most advisers say that 10% is a minimum savings target. But twentysomethings finally seem to have got the message when it comes to the importance of owning stocks, diversifying, and staying away from plan loans.
401(k) plans are now the most widespread employer-sponsored retirement vehicle in the U.S. At year-end 2011, some 51 million Americans were in a plan and they had total plan assets of $3.2 trillion, reports the Employee Benefit Research Institute. It’s critical that all workers handle this kitty with care—but especially so with young people who in retirement are less likely to have a traditional pension or be able to get by on Social Security benefits.
So it’s heartening to learn that young workers are exposed to stocks and allocating assets in a sensible way. Studies show that asset allocation is more critical to portfolio performance than securities selection. Meanwhile, 401(k) loans pose all sorts of problems and there is ample evidence that workers in their 40s and 50s misuse these loans. The good news here, EBRI reports, is that those on the job less than five years are less likely to have an outstanding 401(k) loan than every cohort up to near retirement age.
Why are young people with 401(k) assets doing so well with their investment mix? There is no question that many have learned from the recent economic downturn; that they have a better understanding of what it will take to provide for their own financial security. They also seem to know what they don’t know—and are flocking to investment options that handle diversification and asset allocation decisions automatically.
The favored investment choice of young 401(k) participants is target-dated mutual funds, which automatically shift assets as the account holder ages. These funds guarantee that a twentysomething will be appropriately heavy on stocks, and then slowly shift to bonds by retirement age.
Vanguard notes that 64% of all new participants in 401(k) plans that it administers put all of their contributions into a single target-date fund and that by 2016 more than half of all participants will have all their assets in one of these funds.
EBRI found that 31% of 401(k) assets in the accounts of Twentysomethings were target-date funds. Another 33% of this group’s assets were in straight equity funds. Add in company stock and it appears that young people have about two-thirds of their assets in stocks. That’s a little light; they should probably have 85%. But it’s not bad, considering that money has been flowing out of stock funds for five years.
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Target-date funds have drawbacks. Some have high fees. Look for those that charge less than .5%. Asset allocation models can vary widely. Your percent exposure to stocks should be about equal to your age subtracted from 110. (At age 25, that means 85% stocks.) These funds do not account for outside investments. Your total portfolio should always be in sight. And target-date funds robotically move assets according to age with no consideration for market conditions. You could end up shifting out of stocks and into bonds at just the wrong moment.
Still, it’s largely due to the popularity of target-date funds that young people with 401(k) assets are reasonably well diversified. That’s a nice start.