Young Investors Should be More Conservative?

By JLP | November 30, 2008

I read an interesting and shockingly unique piece of financial advice the other day which Ive been turning over in my mind ever since.

The advice was embedded in a very typical personal finance article on retirement under USA Todays 21st Century Retirement collection. The title of the article is How should you invest in a bad economy? Stocks? Bonds?

You can imagine the predictable advice this (nevertheless valuable) article spelled out; the experts suggested what financial moves people should make now, based on their ages.

Heres the interesting part, outlined under the If youre in your 20s … section:

One mistake young investors make is confusing the principle of investing aggressively with making risky investments, says Sheryl Garrett, founder of the Garrett Planning Network, a network of advisers who charge by the hour. In your 20s, you should be putting at least 80% in stocks.

But ignore the advice that you should make your riskiest investments when youre young. You have lots of time — which means you can invest in a conservative stock fund, accept a lower return, and still reach your goals without worrying about catastrophic losses. Theres no need to be in tech stocks or emerging markets, Garrett says. You can find great opportunities in stodgy old-fashioned blue-chip stocks.

(emphasis mine)

This has actually never crossed my mind, Im sort of embarassed to say. But its remarkably true and sensible. I dont need risky alternative investments nor do I need to pay more for funds which offer them because of all the years I have until retirement. This seems counter-intuitive since you always hear that investors should be more conservative the older they are.

Thats true, but theres a window. Very young investors can afford to be conservative because compound interest and time will account for most of the gains we dont need the to take the risk that comes with the possibility of an extra percentage point or two of return. Older folks need to be conservative because they have to make what they have last they dont have time to earn it back if they make risky investments and hit a long losing streak.

The middle group, those starting in their late 30s or 40s or even 50s, are the group who might most reasonably choose riskier investments because they might really need the possibility of that extra percentage point or two of returns.

This seriously might change my asset allocation forevermore. I am currently a pretty risky investor. My retirement portfolio is 95% stocks, almost half of which are international, almost half of which are emerging markets. Ive also got a fair dose of small caps and REITs. Basically everything including the kitchen sink. But duh! because Im in my 20s I can, and perhaps should, be less aggressive with my investments and still reach my goals.

And isnt that the objective to acheive our goals while taking as little risk as possible? After all, if you won the lottery and were set for life, wouldnt you just park at least most of that money in cash and bonds? You wouldnt need to risk it by investing in stocks and other riskier investments.

13 Responses to Young Investors Should be More Conservative?

The ultimate answer to the age/risk/asset allocation equation depends on whether your goal is to maintain a relatively stable lifestyle through your working life and then in retirement (i.e. consumption smoothing). With that as a goal, the risk-taking and timing can look radically different from what conventional financial planning now teaches.

Don Says:

The middle group needs to realize that they are not going to retire on time (because they started late) and plan to keep working.

The other factor that should be considered in minimizing risk is current valuation levels. Stocks are currently trading at a 50% discount from last year prices. I believe this to be an exceptional buying opportunity if your investment time horizon is greater than a year. My pick is the Monetta Young Investor Fund which is half indexed to the S&P 500 index and the other half invested in Best Of Breed companies like McDonalds,Walmart and Google. Now is not the time to be conservative, these stock buying opportunities are rare and at this could be considered a conservative long-term investment choice.

I definitely invested in index funds most of my life and dont plan on changing

The only other stocks Id consider are Google, Coca-Cola and Wal-Mart

Steve Braun Says:

Sheryl Garret is absolutely correct. There is no need for young persons to tilt their asset allocations to the risky side. Taking excessive risks at a young age, and losing, negates many of the advantages of compound returns over time.

Its important to note that Sheryl distinguishes between aggessive and risky. She doesnt mean young persons should be conservative in the classic sense because her recommendation is 80% stocks. Thats an aggressive allocation of equity. What shes saying is that within that allocation of equity, dont bet the farm on a few frothy sectors in hopes of hitting it big (which is risky).

To boil it down: Be aggressive with respect to your allocation in equities, but be prudent (conservative) in your diversification of risk among equities. Diversify, diversify, diversify!

@ Meg Given what you shared, Id characterize your current portfolio as highly speculative with about 24% in emerging markets and another 24% in non-US developed markets, plus the fair dose of small caps and REITs. Theres nothing wrong with these particular investments as long as your money is prudently allocated among them all in the right proportions. Your current allocation is out of whack. Im glad Sheryls comments have changed your mind. Now act on it!

On a related noteGiven that the majority of your money is heavily weighted toward investments that have been hot in recent times (at least up through 10/2007), could your selections have been driven by performance chasing on your part? I hope not because thats usually a recipe for disaster, leading many to buy high and sell low. Its better to find the proper allocation and stick with your plan, rather than worrying about which assets or market sectors are hot or cold.

This is what comes of generalizing. Young people CAN afford to be more aggressiveif they want to. They dont need to though. Thats the point of starting young. Just because youre young doesnt mean you should push your risk tolerance more than youre comfortable with.

The articles argument makes intuitive sense if you think about it. Younger investors CAN invest more aggressively if they want to. Many will choose to do so. Many will choose not to. A young investor with 50% of their portfolio in bonds is still much better off than one who shot for the moon, suffered terrible losses, and swore off the stock market forever.

I am a post grad and to be honest have very little knowledge of investing or what/how to invest. To me its a huge gamble and I dont have the knowledge to just put money into the markets especially now. But I am young and hopefully the economy would bounce back, so maybe now is a good time to buy. I have been told to put money into a mutual fund over individual stocks. What do you think?

Craig

Im a firm believer in not keeping all your eggs in one basket. I want to collect a lot of different stocks in quality companies for the lowest prices.

I like picking my own individual stocks, because I just plain dont trust other people with my money.

But I dont place all my riches in such volatile holders. I have plenty safer reserves in cash, and CDs as well.

Diversification will be your salvation.

bigbartha Says:

a) I dont understand why Meg has 95%, and not 100%, of her retirement portfolio in stocks. Im in my mid-20s and have 100% of my investments in stock (Roth IRAs and Roth 401ks). If youre younger than 35, you have at least 25-30 years that you could keep this allocation. While stocks dont always perform in the short-term, they consistently out-perform other traditional asset classes, such as bonds, in the long-term. A perfectly diversified stock portfolio by definition will always out-perform a perfectly diversified bond portfolio if you have a long enough time horizon. (Bonds cant actually pay returns higher than the stock market because there would be no way for the issuers to consistently generate the income to pay the bonds).

Meg mentioned that the objective is to acheive our goals while taking as little risk as possible. I disagree. One has to compare the risks and rewards of each investment opportunity. If 1) the possibility of rewards outweigh the possibility of losses, and 2) youre willing to bear the risk of losses, then you should be willing to make that investment.

I particularly find Megs goal difficult to swallow because 1) it appears to be willing to settle for less (mediocrity in returns), rather than seeking to maximize returns, and 2) its difficult to predict how much money well need in the future.

b) With respect to the conservative vs. aggressive investing, diversification is key. Not too many people can accurately predict which market sector or which global region will produce the greatest returns, and nobody has demonstrated how to find these people. That being the case, it makes sense to diversify across both sectors and geographic regions.

Interesting take. I have found that older people tend to chase growth more than younger people. They try to make up for a lack of savings when they were younger.

Gerard Says:

I think the key issue being missed is the ultimate reason for investing. Are you looking to grow your funds aggresively or obtain a reasonable return with some potential downside or safeguard your current investment. The equation of risk depends on whether youre talking to a 20yr old whos currently earning 20K or one earning 200K and what lifestyle theyre willing to accept in retirement. A blanket, one-size-fits-all approach is generally useless to everyone since it is too general to meet anyones specific circumstances.

The other thing to consider is each persons risk threshold. Eg. Im quite happy with risky investments accounting for 15-20% of my portfolio as I can mentally accept losing that amount. However, anything over that would lead to sleepless nights, no matter what return I may be able to obtain

To each their own

mike Says:

Compare the two in the long run. If you put in a fixed amount every year with a 10% return over 40 years versus putting in the same fixed amount with a 9% return over 40 years, you'll end up with 32% moremeaning you need to contribute about 3/4 as much to the 10% return portfolio as you would to the 9% return portfolio to acheive the same goal.