Are today’s 20- and 30-year-olds less willing to take investment risk following the latest bear market and recession than their age group was in earlier times?

Some are, and some are not.

As stock prices have gone through wide swings in recent memory — with the Standard & Poor’s 500 Index plunging 57% from its all-time high of October 9, 2007 to the low of March 9, 2009 and then bouncing back nearly 100% — it’s understandable that young investors would have varied reactions.

Their views of market risk have depended not only on how much money they can afford to invest but also on the ways they invest: as employees in 401(k) defined contribution (DC) plans, individuals invested in IRAs, people investing outside tax-deferred accounts, “non-working” spouses self-employed and so on.

What’s more, opinions also could have depended increasingly on relatively new DC plan factors whose significant features may not yet be widely understood.

The importance of greater understanding was brought out at the recent annual meeting of the Investment Company Institute, when ICI Chairman Edward C. Bernard gave special attention to investors under 40 as he recalled recent ICI investor surveys’ findings that “across a wide spectrum of ages, investors have a reduced appetite for risk.”

“What’s particularly striking,” the T. Rowe Price Group vice-chairman says, “is that … Americans born in the 1970s — today’s 30-somethings … are less willing to take investment risk than their counterparts born in the 1960s … this group is shy about investing in stocks.” In 2010, the share of households headed by 30-somethings that own stocks was lower than in any other cohort born after the Great Depression, he noted.

A few days after he urged ICI members to help the younger generation understand the power of long-term investing “to overcome short-term setbacks and to outrun inflation over time,” a contrary impression of younger investors was conveyed by The Vanguard Group when, coincidentally, it issued an 11-page paper, Generations: Key drivers of investor behavior.
Vanguard’s survey — its first study of the generational differences in equities investing among participants in the retirement plans it administers — doesn’t only yield significant findings, but it offers reasons why differences may exist.

The thrust of the conclusions of co-authors John Ameriks, head of Vanguard’s investment counseling and research group, and Stephen P. Utkus, head of its center for retirement research: many in the younger generations have indeed accepted the risks always inherent in equities.
“While there is evidence that overall equity ownership among younger generations of U.S. investors has fallen in recent years,” they write, citing ICI data similar to those to which Bernard refers, “we find that, within DC plans, younger investors actually have higher equity allocations than (earlier investors) had at the same age.”

Why? There are two recent changes in plan and investment menu design resulting in major enhancements of employers’ 401(k)-type DC plans authorized under the Pension Protection Act (PPA) of 2006 and the Labor Department’s and Internal Revenue Service’s associated regulations.

They are:

Automatic enrollment of employees

Instead of still postponing enrollment in plans indefinitely, under PPA employees must opt out of participation or be enrolled, thus meeting Labor’s goal of increased enrollment. PPA also relieved employers of concerns about (a) legal liability for market fluctuation and (b) the unhelpful investment of employees’ contributions in low-risk, low-return “default” investments for workers who are many years from retirement.

Target-date funds as default options

For employees who become participants but can’t decide how to invest their contributions, more employers can and do offer target-date funds which satisfy Labor’s definition of “qualified default investment alternative:” a mixed asset-fund that is “appropriate as a single investment capable of meeting a worker’s long-term retirement savings needs.”

How do target-date funds satisfy the Labor Department’s requirements? By having a portfolio whose stocks/bonds/cash/mix takes into account an individual’s age or retirement year.
How does a sponsor do that? Usually, by choosing appropriate portfolio mixes for people retiring in, or around, every fifth year (2025, 2030, 2035, etc.) and bringing investors there from first investment to the year for which the fund is named by automatically reallocating assets (replacing stocks with bonds) regardless of markets, as fully disclosed in advance.
“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,” Ameriks and Utkus write, adding a forecast: “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.”