Two Yale professors say young people should borrow money to invest in the stock market.
Sounds crazy, I know. Here’s their rationale:
Traditional retirement advice says you should invest 10 to 15 percent of your income.
That money should be divided between stock funds and bond funds according to your age. A 25-year-old might want to be 90 percent in stocks, 10 percent in bonds, for example. A 60-year-old might decide to be 50/50 in stock and bond funds.
The problem with this advice, say Yale business and law professors Ian Ayres and Barry Nalebuff, is that 20-year-olds haven’t saved much yet. Fifty- and 60-year-olds have a higher net worth.
Although a 60-year-old has reduced the percentage of his portfolio exposed to stocks, he has more money exposed to risk – exactly when he’s least able to recover from a wipe-out.
Conversely, the 25-year-old may have 90 or 100 percent of her portfolio in stock funds. But that’s only a couple thousand bucks.
Jill is 25. She has $2,500 saved for retirement. Ninety percent of that, or $2,250, is invested in stock funds.
Wendy is 60. During the past 40 years, she’s amassed a retirement portfolio of $680,000. Half of that, or $340,000, is invested in stock funds.
When the market drops 3 percent, Jill loses $67. Wendy loses $10,200.
The solution? According to Ayres and Nalebuff, twentysomethings should borrow money to invest in their retirement account.
“It is obvious that you’re not well diversified if you invest $100 in one stock, $200 in another and $300 in a third. You’d have less risk investing $200 in each of the three stocks,” they co-wrote in a column in Forbes Magazine. (They’re assuming each stock is equally desirable).
“The same idea of equal investments applies to investments across time,” they say. “If you have $100 invested in year one, $200 invested in year two, and $300 invested in year three, you have too much exposure to year three and not enough to year one …”
They argue that people borrow money to buy houses, so why not stocks? (Of course, they neglect to mention that you can LIVE in a house, regardless of its market value. You can’t live in a stock portfolio.)
Regardless, the two professors offer an interesting theory. What do you think? Could twentysomethings – counter-intuitively – reduce their risk by borrowing money to invest for retirement?