Smart Millennials Can Be Dumb Investors
Millennials, also known as Generation Y, are an interesting group of people. The term typically refers to those born between the early 1980s and 2000. The general perception of this generation is mixed. Some articles portray them as selfish, lazy and entitled. Others report they have a community spirit.
A study published in 2012 in the "Journal of Personality and Social Psychology" co-authored by Jean M. Twenge, W. Keith Campbell and Elise C. Freeman found that millennials are "more civically and politically disengaged, more focused on materialistic values, and less concerned about helping the larger community" than previous generations.
On the positive side, the study concluded that millennials are more inclined to volunteer and less prejudiced on race, gender and sexual orientation.
The way millennials should invest. Whether it's earned or not, millennials have a reputation for being materialistic and overly concerned about money, fame and image. That's unfortunate on many levels. But the especially bad news for this group, given the perception of their superficial goals, is that they are dumb investors.
Millennials have a long time horizon until retirement. Someone born in 1990, and who is planning to retire at age 65, has 41 years to accumulate enough assets to reach their retirement goal. A responsible and intelligent plan for this hypothetical investor would be very simple: Invest 100 percent of your assets in a globally diversified portfolio of low management fee index funds, exchange-traded funds or passively managed funds.
Slowly change your mix of assets as you age, reducing the percentage of your portfolio allocated to stocks and increasing the percentage allocated to bonds. As a rough guideline, when you reach age 50, your portfolio should be 50 percent to 70 percent in stocks with the balance remaining in bonds. Rebalance periodically.
A critical element to the success of this plan is ignoring both the financial media and short-term market fluctuations. The market has always increased over the long term. A major reason investors do not reach their retirement goals is that they panic, selling when the market goes down and buying after the market has already gone up. The key to successful investing is sticking to a plan, which often requires sitting still.
Following this advice is more difficult than it sounds. Brokers and the financial media inundate investors with a daily dose of misinformation. This largely consists of predictions by "financial pros" and recommendations for underpriced stocks or "hot" mutual fund managers.
The way millennials actually invest. Unfortunately, millennials have a basic misunderstanding of risk. BlackRock's "Global Investor Pulse" survey found that almost half of its 4,000 participants were opposed to taking any risk with their money, keeping it in cash or bonds. The participants included investors of all ages, "with those born in the late 1970s and after leading the way."
Here's what these investors do not understand. An all-cash strategy seems conservative, but it is actually both risky and foolish. It's risky because inflation significantly erodes purchasing power over time. An all-cash portfolio will not keep pace with inflation and practically ensures a loss of purchasing power. An all-cash strategy is foolish because the expected return from even a conservative allocation of stocks in a portfolio is likely to at least keep pace with inflation.
A UBS survey published this year, "Think You Know The NextGen Investor? Think Again," found the 2008 financial crisis had a powerful impact on millennials' tolerance for risk. For example, 70 percent of participants described their risk level as "moderate," "somewhat conservative" or "conservative."
These investors hold dramatically higher cash allocations than other generations and are particularly wary of stocks. Only 28 percent of those polled listed "long-term investing" as a major component of their plan to achieve success, compared to 52 percent of nonmillennials.
The right way to perceive "risk." These attitudes, which reflect both the effect of the 2008 financial crisis and an appalling lack of familiarity with basic principles of investing, doom millennials to a future in which they fall short of their retirement goals. If millennials took the time to understand risk, they would view investing differently.
"Risk" has become a pejorative term. But investors are rewarded for taking risk. Without risk, it would be impossible to achieve inflation-beating returns. The mistake made by many investors is that they seek significant returns without taking risk.
Offering investments that make such a promise is a common practice among those engaged in illegal or fraudulent conduct. There's a reason Treasury bills and certificates of deposit, backed by the full faith and credit of the U.S. government, are referred to as having a "risk-free" rate of return. They are currently paying less than 1 percent.
A ray of hope. There is a glaring exception to the investing attitudes of many millennials. Tech-savvy employees in Silicon Valley have embraced evidence-based investing and are flocking to firms offering low management fee index funds, ETFs and passively managed funds.
More millennials should follow their lead.
Dan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth advisor with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book is "The Smartest Sales Book You'll Ever Read."
