How Generation Hexed Can Overcome Its Fear of Investing
The past 12 years have been a particularly lousy time to come of age, financially speaking. The Internet bust of 2000 set an ominous tone, which grew to a crescendo with the stock market plunge of 2008 and early 2009.
These episodes have scarred younger investors. The Investment Company Institute, the trade group for the mutual fund industry, reports that as a whole they are now less likely to own stocks than in the past.
Obviously, experience matters. Studies show that older investors trade less, have more-diversified portfolios and are less prone to mental traps that trigger poor investment decisions.
But a case of the stock market willies could be especially harmful to novice investors. After all, the classic thinking is that younger people should have riskier portfolios stuffed with stocks because they have so many years to ride out the ups and downs of market cycles. Target-date retirement funds designed for young investors, for example, are almost all stocks.
The British Approach
Across the pond, the Brits have come up with an interesting solution to this problem. This is the first year of a major overhaul of the retirement savings system in Great Britain. Basically, most employers there must provide a retirement savings plan. Those that don’t want to hire a private provider may use the government-sponsored plan, the National Employment Savings Trust. NEST uses many of the best practices pioneered in the U.S. For example, workers are automatically enrolled; if they want out, they must opt out. That takes advantage of people’s natural inertia to nudge them into saving.
But the British have added an original twist. Mark Fawcett, NEST’s chief investment officer, explains that during the credit crisis of 2008, many young retirement savers were frightened into making poor choices, such as stopping contributions or moving their nest egg to cash. Of course, that meant they locked in their losses and missed the stock market rebound that has taken place in the U.K., just as it has in the U.S.
So, Fawcett says, the problem boiled down to persuading more young investors to enroll in a retirement savings plan and stay there. The NEST solution was to reengineer some investments, keeping in mind the fearfulness of young investors. Instead of offering riskier target-date retirement funds that start out heavy on stocks and gradually grow more conservative as the years pass, the plan puts newbie investors into conservative funds that become aggressive as investors mature and can better handle risk.
Here’s how it works. A 22-year-old retirement saver starts with contributions to a target-date-type fund with a low percentage of stocks and, therefore, low risk. By the time he turns 27, his portfolio has a moderate allocation to stocks and increased but moderate risk. And by the time he is 30, he is invested almost entirely in stocks. As the Brits would say, brilliant.
But wait. Aren’t investors missing out on big returns when they’re young? “Maybe,” says Fawcett, “but there’s virtually no impact on the size of the final pot.” That’s because retirement savings balances are relatively small when investors are starting out. “The most important thing is the amount of risk they’re taking in later years when the pot is really big,” he says.
Similar funds for younger investors don’t exist in the U.S. So what would help anxious twentysomethings here save for retirement?
John Ameriks, head of the investment counseling and research group at mutual fund giant Vanguard, says two misconceptions need to be dispelled. First, he says, many young people have the mind-set that they’re either in stocks or they’re not. “If you don’t feel comfortable putting 90% in the market when you’re young, put in 45%,” Ameriks advises. Second, “Never let the risk involved in the stock market stop you from starting a savings program.”