Hitting the snooze button on retirement savings is way too easy. Retirement is far away and you have plenty of time to figure out how to invest those savings piling up in your 401(k) account, right?
Time may not be on your side.
The way savings are invested through your career will have a direct impact on the amount of money you end up with in retirement. Despite the magnitude of the decision, many people may underestimate the importance of planning their portfolio, or asset allocation.
Over a third of households with defined contribution plans have extreme asset allocations, according to a recent analysis by HR consulting firm Towers Watson of the triennial Federal Reserve report, the Survey of Consumer Finances. Analysts at Towers Watson looked at the three reports between 2004 and 2013.
Here’s a summary of some of their findings over the nine-year time period:
- More than one-fifth, 22 percent, of all workplace plan investors hold only equities.
- Fifteen percent of defined contribution participants have no money in stocks.
- Nearly 16 percent of investors between the age of 25 and 34 have no money in stocks.
- About 18 percent of investors between the ages of 65 and 74 invest only in equities.
The problem with all-or-nothing in stocks?
On both ends of the age spectrum, many investors are at risk of being mildly not-right to extremely wrong about their asset allocation. The only caveat is if the investor has other investment accounts; for investors with multiple investment accounts, the 401(k) would reflect only a portion of their overall asset allocation. But let’s assume that’s not the case.
For the 16 percent of young people with no money in stocks, they are losing out on valuable growth that could boost their savings efforts during the formative years of their career. They have a lot of time to recover from any stock market downturns, and every little bit of extra return can boost the amount of money available for compounding over time.
Plus, here’s an interesting tidbit from the Towers Watson analysis:
Human capital (expected future earnings) is generally considered bond-like, thereby offsetting the risk associated with equities for younger workers, with the risk offset declining gradually over their careers.
In other words, not only do they have lots of time for investments to recover, they have many potential working years in front of them. As their career winds down, the cushion of future payments they can look forward to also dwindles.
For investors near retirement, 18 percent of those over age 65 who hold only equities run the risk of having their retirement income crippled by a market downturn, particularly if they need to start drawing on their 401(k) in a down market. Being all-in equities can heighten that risk as opposed to a more diversified portfolio with safe investments to mitigate market volatility.
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Senior investing reporter Sheyna Steiner is a co-author of “Future Millionaires’ Guidebook,” an e-book written by Bankrate editors and reporters. It’s available at all the major e-book retailers.