by Kevin Feldman, iShares
Young investors who keep their money in cash may think theyâre playing it safe, but the strategy could cost them in the long run.
A recent Bank of America-Merrill Lynch survey found that almost half (47%) of 1,000 affluent Americansâdefined by Merrill as Americans with investable assets in excess of $250, 000âdescribe themselves as âconservative investors,â meaning that they favored low to moderate risk investments intended to deliver modest but steady gains. Among young investors aged 18 to 34, that number soared to 59 percent. (As compared to 41% among investors aged 35-64.)
Whatâs striking about these findings is that theyâre basically a reversal of conventional financial wisdom, which holds that younger investors should take on more risk than older ones; since they have more time before retirement, they can afford to be more aggressive in search of greater gains, which are then compounded over decades. Older investors, however, wonât have as many years before retirement to recover from potential large downturns in riskier investments. Younger investors are typically the ones who buy growth-oriented equities, while older folks are typically the investors moving their portfolio into less risky and income-generating investments.
Whatâs going on? The consensus is that older investorsâ attitudes were shaped by the long-running bull market of the mid-1970s through the late 1990s. Younger investors, however, had less time to form positive impressions of the market before being hit by two crises in less than a decade: the bursting of the tech bubble in 2000 and 2001, and the recent market plunge of 2008 and 2009. So while older investors saw a quarter-century of upward movement before a sustained plunge, younger investors saw deep drops bracketing a few years of growth.
Given the economy, younger investors are also likely to have an understandable fear of unemployment, and so want to keep cash on handâas opposed to investing it in equities that, in their experience, can suffer massive drops in value. Itâs the modern equivalent of people who lived through the Depression stuffing cash under their mattress.
I can understand why younger investors lack confidence in equities, but I canât endorse the strategy. Playing it safe in reaction to past crises is investing by looking in the rear view mirror, and ironically, it really isnât playing it safe at allâmore like the opposite.
For two reasons. One, investors who allocate too much of their retirement portfolio to cash or fixed income will likely lose out on the higher gains that equities have historically generated over long-term periods. Theyâll also lose out on the compounded value of those gains between now and their future retirement years.
And two, they may lose money by not keeping up with inflation, as is entirely possible when keeping your money in cash or short-term bonds, particularly at current interest rates. Most financial advisors would tell you that only if you strongly believe weâre headed for deflation, or if you have a near-term plan for a major purchase such as a home, does it make sense for a younger investor to hold 1/3 of his or her portfolio in cash.
This is the kind of longer conversation that investors should really have with their financial advisors, of course. But broadly speaking, for younger investors the old advice is still sensible: Start saving as early as you can and donât stop. Diversify, diversify, diversify. Keep costs low and be tax savvy in where you place your investments.
Keeping your money under the mattressâfiguratively or literallyâis not the road to a comfortable retirement.
Diversification may not protect against market risk. Past performance does not guarantee future results.
