Most Young Retirement Savers Make This Investing Mistake
You've set up your 401(k) contributions, and you're watching that account balance tick up with every paycheck. Congratulations, you're on your way to a comfortable retirement. Now, it's time to expedite your progress by optimizing the investments in your account.
That's an adjustment the vast majority of young savers need to make, according to a new report from insurance company John Hancock. The report finds that 81% of DIY savers under the age of 30 are invested too conservatively for their age. And while that may not sound like a catastrophic investing mistake, it's likely to slow the growth of your retirement savings over time.
Granted, there are good reasons why you might prefer to be conservative with your retirement account holdings. At a time in life when your 401(k) contributions represent most -- if not all -- of your savings, you don't want to take any chances. Or perhaps you're still getting comfortable with the risk of loss that comes with stock market investing.
A window of opportunity
Still, a different perspective might encourage you to branch out of your comfort zone. Let's say you're 25 years old -- generally, you aren't supposed to pull funds from your 401(k) until you reach the age of 59 and a half. You have more than 30 years to weather any kind of market storm, and that's significant because the U.S. stock market has never recorded a loss over a 30-year, or even 20-year, timeframe.
That means you can afford to invest aggressively in your 20s and 30s, but the window doesn't stay open forever. As your retirement timeline gets shorter, normal market fluctuations become more and more threatening. A big market correction just before you start taking retirement distributions could quickly undo years of saving. At that point in your life, you should be investing conservatively to protect the wealth you've already built.
It's not exactly a "now or never" situation but pretty close. You have 10 or 20 years to build some serious savings momentum before you have to change course. You can even quantify what's at stake using a compound interest calculator. Say you're investing $500 monthly. The difference between a conservative 4% growth rate and a market-level 7% growth rate adds up to about $67,000 over 20 years.
Positioning your retirement account for growth
If that $67,000 caught your attention, here's what to do next. Check the asset allocation in your 401(k). Your asset allocation is the composition of your investments across stocks and bonds. It's also a primary factor in your portfolio's risk level and growth prospects. Stocks are riskier with higher growth potential, while bonds are safer but fairly stable in value.
If you're under the age of 30, and stocks make up less than 70% of your holdings, you may be invested too conservatively. An equity allocation of 80% to 90% would be more appropriate.
That range comes from the Rule of 110, which is an asset allocation guideline tied to your age. To use the rule, subtract your age from 110 -- the resulting number is the percentage of stocks you should hold. Follow that guideline over time and your asset allocation gradually gets more conservative as you grow older. At age 30, you're holding 80% stocks. Five years later, you'd move down to 75%. By the time you celebrate your 65th birthday, stocks will comprise less than half of your portfolio.
Take advantage while you can
For most savers, the stock market is the simplest and most accessible way to build wealth. Take advantage of it while you still can. Give yourself a decade or two to make rapid progress, and then you can return to your conservative ways. In 20 years, you'll appreciate that you didn't do things the other way around.
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This article was written by Catherine Brock from The Motley Fool and was legally licensed through the Industry Dive publisher network. Please direct all licensing questions to legal@industrydive.com.
