IRA Accounts Gone Wild: More Than Half Carry Extreme Risk
Either all-in on stocks, or holding next to none
Individual retirement accounts are a key piece of many households’ retirement savings. Of the nearly $40 trillion sitting in retirement plans in 2019, about $11 trillion was parked in IRAs.
The Employee Benefit Research Institute, with its massive database of more than 11 million IRA accounts, reports two separate but equally shocking levels of risk:
—One-quarter of all IRAs had less than 10% invested in stocks, making it highly unlikely their holdings will keep pace with inflation, let alone produce the 5%-to-10% gains that can provide for a comfortable retirement.
—And nearly 30% had more than 90% invested in stocks, leaving the accounts overexposed to bear markets.
The extreme approaches aren’t limited to IRAs of younger savers. One-quarter of IRA owners at least age 65 had more than 90% invested in stocks. That is incredibly aggressive.
While it is indeed smart — and necessary — to keep a portion in stocks to combat the corrosive effect of inflation over a retirement that may easily last at least two decades, 90% puts security at risk if there is an extended period of poor performance, especially in the early years of retirement. When you’re pulling money out of accounts to cover living expenses, withdrawals from accounts that have lost value create a hole that is hard to climb out of.
Worth considering: The Vanguard Target Retirement 2020 Fund, a portfolio with an allocation deemed appropriate for someone retiring right about now, has about 50% of its assets invested in stocks.
Meanwhile, more than four in 10 adults under the age of 25 had at least 90% sitting in cash. If ever there were a time to have 90% in stocks, it is when you are young and can take fullest advantage of compound growth.
Earning 1% or less in money market and cash accounts (the going rate these days) completely misses the compounding boat. When retirement is 40 or more years off in the future, you’ve got all the time in the world to ride out market volatility. For the record, the Vanguard Target Retirement 2060 Fund has 90% invested in stocks.
There could be a perfectly rational explanation for the extreme allocations. Many households may also have workplace 401(k) plans. If someone with 90% of their IRA in cash has an equal amount of their 401(k) in stocks, their total allocation may be more appropriate. But that’s a mighty big if.
If you’re nearing retirement, the stock market’s performance over the past two years may be lulling you into thinking you can afford to stay aggressive. Each time stocks have taken a big hit, they have bounced back fast. In late 2018, the S&P 500 fell nearly 20% from September through Christmas. Then it rallied fast and furious, and recouped its losses by early April. The near 35% drop during the coronavirus meltdown that hit bottom in late March, was followed by an epic bounce-back that recouped the big loss in early August.
That is a lot faster than normal. And it has much to do with aggressive Federal Reserve policy. Maybe this is the new normal. And maybe not.
Since World War II, the bear market norm is that the S&P 500 keeps falling for more than a year, and then once it bottoms it takes an average of two more years to get back to break even. The financial crisis bear market saw stocks fall for nearly 1.5 years, and then it took another four years to get back to breakeven.
For young investors, the system is often part of the problem. When someone with a workplace retirement plan that has less than $5,000 in assets leaves a job — more likely when that person is young — the plan is allowed to impose a “forced cashout” that moves the money out of the plan and into an IRA account.
And when the money arrives at the IRA it is by default put in cash, awaiting the account holder’s direction on how to invest the money. That often doesn’t happen immediately, which squanders the compounding opportunity.
The good news is that with a small time investment anyone can nail the right allocation approach for their retirement accounts. The brokerage where you have your IRA likely has an asset allocation tool that will walk you through some questions and suggest a reasonable mix of stocks, bonds and cash based on your age and tolerance for risk. Or search “Vanguard determine asset allocation” — you don’t need to be a Vanguard client.
Once you’ve settled on a logical allocation, you need a system to push yourself to check once a year to see if you need to “rebalance,” which is investing-ese for moving money around the funds or exchange-traded funds you own, to make sure you’re back close to your target allocation. Or you might consider a target date retirement fund. Nearly every brokerage offers ’em. Your allocation is set based on your age, and the fund handles the rebalancing for you.