Young People Are Loading Up on Stocks

NEW YORK (TheStreet) -- After suffering through a decade of volatile markets, many young people have soured on stocks. Investors who were born from 1970 through 1979 have less than 40% of their assets in stocks, according to a study by Investment Company Institute. In contrast, investors who were born from 1950 through 1959 retain faith in stocks, keeping more than 50% of assets in equities.

Seeing the data, pundits have worried that a generation may have abandoned the stock market. But that assessment is too bleak. While some investors have undoubtedly turned away from trading, young people have been increasing the stock allocations in their 401(k) plans. The transition to equities has occurred steadily in recent years -- even during the financial crisis. According to a study by Vanguard Group, participants in their early 20s had 41% of 401(k) assets in equities in 2003. By 2010, savers in their early 20s had 85% of assets in stocks.

Are the young plan participants eagerly anticipating another big bull market? Probably not. Much of the shift in 401(k) plans can be traced to the growing use of target-date retirement funds. The funds automatically put young people into hefty stock allocations. Many plan participants know little about investing, but they are opting for the target-date choices because the funds are promoted by employers.

According to the Investment Company Institute, new plan participants in their 20s now put about 44% of their 401(k) assets in target funds and other balanced funds. That is a big change from 1998 when young participants only put 7% in the funds. Target-date funds now have $374 billion in assets, up from $71 billion four years ago.

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Holding diversified collections of stocks and bonds, the target funds are designed for savers who will retire around a certain date such as 2020 or 2050. As the savers age, the asset allocations are adjusted. Funds that serve savers in their 20s or 30s can have as much as 90% of assets in equities. The equity allocation is reduced as the retirement date approaches. Retirees can have less than 40% of assets in stocks.

The target funds have become wildly popular because they are easy to use. By selecting a single fund, a saver can maintain a diversified portfolio that holds retirement assets for decades. Many employers believe that the introduction of target-date funds has represented a big improvement for retirement plans. Before the target funds appeared, plan participants had to choose from a menu of options, including company stock as well as stock and bond funds. Unsophisticated about the risks of investing, many participants made poor decisions, loading up on bonds or holding big stakes in risky company stock.

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To ensure that plan participants have diversified portfolios, many employers encourage savers to use target funds. An increasing number of plans offer target funds as default options that are used when employees don't specify another choice. The target funds have been popular options in automatic enrollment programs. In these plans, employers automatically deduct money from paychecks and put the cash in 401(k) plans -- unless employees take the trouble to stop the contributions. Researchers argue that the automatic plans have been effective at inducing employees to save.

Although many employers have embraced the funds, the target-date portfolios came under criticism during the financial crisis. The critics noted that many funds suffered big losses. In 2008, target funds with maturity dates of 2016 to 2020 lost 29.5%, according to Morningstar. That was a painful decline, but the funds outdid the S&P 500 by 8 percentage points. "Many people did better with target-date funds than they would have done without them," says John Ameriks, a principal of Vanguard Group.

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Ameriks argues that the move into target-date funds is a positive development for investors. Besides ensuring that investors have hefty stock holdings, the funds automatically rebalance assets to maintain proper diversification. That should boost returns and help investors achieve solid long-term returns.
Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.