Gen Y Takes on More Risk in 401(k)s

Automatic 401(k) enrollment is causing young workers to increase their exposure to equities.


Automatic enrollment of new employees in 401(k) plans is causing young investors to take on more risk within their 401(k) plans than previous generations did at the same age. Many young employees are invested in target-date funds by default, which tend to have high concentrations of equities for workers far from retirement and gradually shift the investment mix to become more conservative over time.

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Investors under age 30 have significantly increased their exposure to equities within their 401(k) plans over the past several years, according to a recent Vanguard report. The average equity allocation for 20-year-old 401(k) participants has increased 44 percentage points from 41 percent in 2003 to 85 percent in 2010. In contrast, there has been a decline in equity allocations among older 401(k) participants over the same time period.

“Recent developments in plan and investment menu design—particularly the growing use of automatic enrollment and the increasing prevalence of target-date funds in defined contribution plans—have played a critical role,” according to the Vanguard report. “These changes have led younger investors to behave differently than prior generations, who were more likely to invest conservatively and remain at these cautious allocations due to inertia.”

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The growing use of target-date funds as a 401(k) investment option, and the default investment for those who don’t make another choice, has significantly contributed to the uptick in more risky investments. Target-date funds allocate your retirement savings into a range of investments including equities, bonds, and cash and gradually shift the investment mix to become more conservative over time. 401(k) participants age 35 and under who own target-date funds held an average of 8.5 percentage points more in equities than employees without a target-date fund, Vanguard found. Among those ages 36 to 54, target-date fund owners held 7.9 percentage points more in equities. Target-date fund owners older than age 54 have only marginally lower stock allocations (-1.6 percentage points) than older investors without them.

Many target-date funds allocate large portions of the fund to equities for young retirement savers. A recent Government Accountability Office review of eight target-date funds found that most fund managers allocate at least 80 percent of assets to equities 40 years before retirement. The way the funds shift to more conservative investments varies widely among different funds. When the funds reached their target retirement date, the equity allocation ranged from 33 percent to 65 percent. Some target-date funds reach their most conservative asset allocation at the designated retirement date in the fund’s name, while others continue to grow more conservative for ten or more years into retirement.

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Automatic enrollment in 401(k) plans impacts young people the most dramatically because typically only newly hired employees, who tend to be younger, are routinely signed up for the 401(k) unless they opt out. These young retirement savers are often enrolled in target-date funds by default if they fail to make another investment choice. “As more and more plans enter the automation age, equity risk-taking by participants will be increasingly the result of plan design and menu choices, and less a function of participant reaction to current market conditions,” according to the Vanguard report.

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