Moreover, the young adult’s job security is also highly correlated with the business cycle. The gray-shaded areas in Figure 1 indicate the three U.S. recessions that took place during our sample period. Naturally, all age groups suffer an increase in unemployment rates during recessions. But, in addition to higher job turnover, higher rates of unemployment, and longer-lasting unemployment, young adults suffer a bigger jump in unemployment—by about 60%—than their middle-aged brethren over 45.
In Figure 1 we also overlay stock market performance over the same time span. The dotted line (right axis) represents the cumulative total return of the S&P 500 Total Return Index. As is obvious from the chart, recessions usually follow a period of market downturns. This should not be surprising because stock market declines typically begin prior to the arrival of a recession. So, young investors’ equity-heavy TDF investments plunge just when they’re more likely to be laid off, and/or just before they cash in their DC fund!
The magnitude of the increase in unemployment experienced by workers in different age groups is shown in Table 1. Here, again, we see that the risk of losing a job when the economy falters has been greater for young people than for their older colleagues.
‘100 Minus Your Age’
Why do we subject our newest savers to the highest risk?
Too often, our industry is addicted to conventional wisdom and allergic to arithmetic and empirical testing. Conventional wisdom suggests a percentage allocation to equities which is “100 minus your age,” and the notion that the young can bear more risk than those of us who are middle aged (or older!). True, the young have more time to recover losses, but what losses are more insidious for retirees than inflation sapping the real income of a bond-centric portfolio? Until we published our “Glidepath Illusion” papers,2 was this conventional wisdom ever seriously tested?
Finance theory was then called upon to justify this untested conventional wisdom. Academia advanced the unexamined thesis that human capital is like a bond, so that, as we age, we should replace our diminishing human capital with bonds. Now we have an established literature which demonstrates that—assuming human capital resembles a bond—we should move from risk-tolerant to risk-averse as we age. Pardon me, but doesn’t employment income feel more like equities, with income typically growing at the rate of inflation plus a bit, and with ever-rising uncertainty the farther we look into the future? Which are more highly correlated with young adults’ income streams: The total returns and income streams for stocks or for bonds? Just asking.
Finally, we are told that the young are tolerant of risk and that, as retirement approaches, the average investor becomes intolerant of downside risk, fleeing after a serious drawdown. To be sure, we all know people of all ages who got out of stocks, including the stocks held in their 401(k) portfolios, at the 2002 and 2009 market lows. But are there studies examining the relative behavior of young adults, mid-career employees, mature employees, near-retirement employees, and post-retirement investors? Are young employees likely to become risk-allergic—let alone risk-averse—if their first major foray into the capital markets ends with the triple-whammy of a lost job, necessary liquidation of their 401(k) at a loss, and a tax penalty to boot?
Now, a huge industry3 has been formed on the basis of conventional wisdom, backed by finance theory which is itself based on a doubtful core assumption and supported by anecdotal behavioral evidence!