You’d think the response to the question “How should I invest for retirement?” would be further, deeper inquiries about the individual hoping to retire someday, and then a nuanced plan considering that information. However, when you boil it down, age is the single most important factor when determining the investment advice you’ll receive from the retirement industry. The guiding principle: younger people get more stock (considered more risky), older people more bonds (less risky). But if you look around your office, you’ll see people with varying income and career trajectories, so the idea that everyone should have the same investment strategy—and risk tolerance—because of age seems beyond nuts.
That’s not the only way in which investment advice can suffer from oversimplification. Consider people with lower incomes, who are often lucky to have a retirement account at all. Several states are now stepping up and offering retirement accounts to people who don’t get such benefits through their employer, which tend to be low earners. Each state is taking a different approach to how the money will be invested. While most don’t offer much choice, there is a uniform push toward low risk investments. The thinking? Low income people can’t afford to lose any money in the market. That also means they have no shot at upside either. For that reason, some in the industry argue the states have it backwards—low income people should have riskier portfolios because they’re already starting from a lower asset base and need to be aggressive.
The states’ approach is closer to how lower earners currently invest. Using data from the 2013 Survey of Consumer Finances, the chart below shows how much stock Americans age 35 to 50 hold in their retirement accounts, segmented by income. I focus on retirement holdings because low-wage Americans often don’t have access to the stock market, but everyone with a retirement account has equal access to the market and is faced with similar investment choices.
As you can see, higher earners typically invest in stocks significantly more than middle to lower earners.
Researchers at Morningstar argue it should be the other way around. It’s not as crazy as it sounds. They point out that lower earners receive a more generous Social Security benefit relative to the income they need to replace in retirement. That benefit ends up representing an overwhelming share of their assets. Assuming Social Security is a safe asset, low earners, from a diversification perspective, should be positioned to take on more risk elsewhere. Another argument is that low income people are being left behind as the economy increasingly favors the owners of capital. Owning stock gives them a way to join that party.
That’s the theory and it makes a compelling argument that low earners may want to take on a lot of investment risk. But the reality is many low earners have meager savings beyond their relatively small retirement accounts. The figure below takes the same group above—people with a workplace retirement account age 35 to 50—and takes the median liquid assets (checking, money market, or saving accounts) for different levels of household wage income.
The lowest income group has less than $2,000 in liquid assets. That means they have almost no financial cushion should they lose their job, need car repairs, divorce, or have a medical event. That leaves their retirement accounts as an emergency saving vehicle. Sadly, many people do use it this way: According to a survey from Aon Hewitt, low salary people withdraw from their retirement accounts at twice the rate higher income people do. Risky investments are a bad idea for an emergency fund because you may need to sell just when the market tanks.
As more people with diverse financial situations have retirement accounts, one thing is for certain: A one-size-fits all investment strategy based on age or some presumed risk tolerance is completely inadequate. There needs to be full consideration of your savings and income—both present and future—to figure out how much risk you can take.