Retirement Planning: Millennials vs. Boomers by Research Affiliates

In a recent piece from Research Affiliates, Rob Arnott and Lillian Wu  wrote that young workers are more likely than older ones to lose their jobs in an economic downturn. They are also prone to draw on their 401(k) plan to meet basic living expenses while they are unemployed. Given these facts, the early-phase concentration in equities—whose market prices are roughly correlated with the business cycle—makes target-date funds (TDFs) inordinately risky for young investors. A starter portfolio invested equally in mainstream stocks, mainstream bonds, and diversifying inflation hedges would be a safer option.

Now, in an article sparked by Rob and Lillian’s work, Noah Beck considers TDFs in the broader context of workers’ total assets, including their own human capital. Millennials’ largest asset is their ability to earn a paycheck, an ability whose value will—much like a common stock—rise and fall with the economy. Baby boomers typically have a bond-like portfolio that includes claims on income from social security and pensions.

Retirement Planning: The Big Picture

Even if a TDF is the only pension that one owns, income from that pension portfolio makes up only a small portion of total income for people over 65. The majority comes from social security, defined benefit pensions, income earned on other assets, and wages, which together already act as the glidepath that the conventional wisdom advocates. Figure 1 shows the breakdown for the current retirement age population according to the U.S. Social Security Administration.

Retirement Planning: Millennials vs. Boomers

Social Security checks account for over a third of the average retiree’s income. This income is virtually guaranteed2 and adjusts for inflation as the recipient ages. If we had to categorize all assets and income streams as “stock-like” or “bond-like” in terms of expected future cash flows, the income from Social Security is very similar to owning an inflation indexed bond (or TIPS). Because income from Social Security depends on how many years a person worked, boomers have a substantial allocation of their total retirement pool to Social Security “bonds.” Do they need more bonds in their TDF holdings? Not so sure. Millennials, still at an early point in their careers, would currently have next to none.

Pension distributions make up another sixth of the pie for current retirees, and defined benefit (DB) pension distributions are also bond-like in nature. Generally the DB plan sponsor assumes the risk of the underlying portfolio and provides the employee with either a guaranteed lump sum or an annuity upon retirement. The value of this benefit, like Social Security, grows the longer you work and the more you earn. DB plans are becoming increasingly rare for new employees, but even for millennials who are lucky enough to have one, its present value would currently be quite low. Boomers with pensions, however, have a second substantial bond-like asset in their overall retirement portfolios.

There is a third asset, crucial to retirement preparedness, in which millennials actually have an advantage over their parents: their own human capital. Boomers who are nearing retirement may only have a precious few years of work remaining; their human capital is largely depleted. But, millennials have decades of employment income ahead of them. They clearly have the higher present value of all future earnings.

For many investors,” Noah writes, “the glidepath to retirement is already in place.” As a result, he suggests, the differences between younger and older investors may not be as stark as conventional wisdom and traditional Target Date Fund investing assume.

Online at: “Retirement Planning: Millennials vs. Boomers

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