Workers who think of themselves as investors do better.
Who is an individual investor?
This term brings to mind a picture of a white-collar professional who actively manages his or her investments. That description indeed is fitting for a certain segment of the individual investor population. But there is a large segment of the working population that does not seem to perceive themselves to be investors, often to their detriment.
Today, defined-contribution plans are the predominant workplace-sponsored retirement plan in the United States. Whereas traditional defined-benefit pensions did not require participants to make many decisions, workers in plans such as 401(k)s are responsible for deciding how much to contribute, how to invest their contributions, and how much risk they are willing to assume. In short, to achieve a secure retirement, these workers must consider themselves to be investors.
I explored this issue in a recent paper, titled “Who Is an Investor?,” relying on the Federal Reserve’s Survey of Consumer Finances for data. Here are the findings, in brief.
The majority of workers who participate in tax-privileged retirement plans, such as workplace-sponsored defined-contribution plans and IRAs, do not pursue investment opportunities outside of these vehicles. We considered these workers to be “unwilling” investors. Unwilling investors comprise 76% of workers who participate in defined-contribution plans and IRAs. They differ from those who do pursue investment opportunities outside of these vehicles, who we consider to be “engaged” investors in several meaningful ways.
We found that unwilling investors have shorter planning horizons than engaged investors did. They were more likely to be focused on the next few months to a year when planning savings and investment decisions. Engaged investors, however, were more likely to report focusing on the next five to 10 years and longer in the future.
This difference even persists across age groups. Younger workers are often preoccupied with other financial obligations, such as paying off student loans and saving for a down payment on a house. But nearly twice the proportion of engaged investors between the ages of 18 and 34 reported prioritizing the next five to 10-plus years compared to similarly aged unwilling investors.
Unwilling investors further indicated that they were less interested in assuming risk than engaged investors. Nearly 80% of unwilling investors reported being either unwilling to take on any financial risks or only willing to take average financial risks expecting to earn average returns. Meanwhile, 40% of engaged investors responded that they were willing to take on substantial risks or above-average risks. This difference, too, exists among younger workers.