A Nightmare on Main Street

Posted in: Economics, General, Stock Market, Thought of the Week

The Employee Benefit Research Institute (EBRI) recently published statistics on how most Americans are saving for retirement that are more frightening than even the most gruesome Halloween costume.

The EBRI gets its data from financial firms that administer Individual Retirement Accounts (IRAs), and they recently analyzed 25 million accounts with combined assets totaling over $2 trillion. One particularly interesting, or scary analysis dealt with “extreme allocations”, where an investor is heavily weighted in one specific asset class.

Diversification is the “Golden Rule” of investing, and investors are to maintain proper diversification across asset classes, sectors, regions, and other factors at all times with no exceptions. For example, the Investment Committee is bullish on U.S. equities over the next 5+ years, but it’s important to remember that there are bad people in this world who want to do bad things. Diversification can shield a portfolio from unexpected shocks like a terrorist attack, whereas extreme allocations leave investors’ portfolios vulnerable to such tragedies.

The Investment Committee found three alarming facts within the EBRI report in regards to those holding extreme allocations in 2010 and 2012:

  1. All or Nothing: Over 33% of IRA owners had no equity in their IRA plans, and 22.5% had all of their IRA money in equities. Therefore, a total of 56% of IRA plans had either all equity or no equity at all.
  2. Not Enough Risk: Those who are saving for a distant retirement, specifically ages 25 to 44, are not properly allocated to equities. In both years, a total of 40.5% had no stock exposure, which is precisely when an investor should have a higher allocation to equities vs. other asset classes.
  3. Seniors at Risk: Of the IRA holders who are 85 and older, a total of 18% had all of their IRA money in stocks. Almost 1 out of 5 in this cohort have an almost inconceivable amount of risk in their portfolios, and they run the risk of outliving their money.

The frightening conclusion is that most investors using IRAs are not properly diversified and have little to no plan for their financial future.


Implications for Investors

The thrills and chills experienced watching a scary movie or by visiting a haunted house are only temporary. In fact, most enthusiasts of both would argue that they are actually quite entertaining.

However, the numbers above are real and the risk to these extreme allocations is even more material. Imagine the fear and panic in an 85-year old retiree who was allocated entirely to equities back in 2008.

Investors simply must have a financial plan at all times that addresses key objectives and needs over the short and long run. The numbers within the full EBRI report indicate that the overwhelming majority of Americans do not have a plan, and the Investment Committee considers this “Nightmare on Main Street” to be far more frightening than any of the Nightmare on Elm Street installments.

The bottom line is that most Americans are not suited to develop and manage a financial plan that can meet their key objectives over the short and long run. This skillset takes years of education and experience to acquire, and we strongly urge those who are not willing to acquire this knowledge on their own to seek the guidance from a financial planner who can balance your needs against your risk profile.

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As an Investment Advisory Representative working in conjunction with Global Financial Private Capital (GFPC) we are provided weekly thoughts on what is happening in the economy and the market. Written by our investment committee at GFPC we find these thoughts to be informative and interesting.