The Huge Retirement Mistake Millennials Are Making

Millennials' distrust of the stock market could make it a lot harder for them to retire.

Jul 28, 2014 at 2:52PM

When it comes to the Millennial generation's retirement prospects, there's good news and bad news.

The good news: Some Millennials are actually saving for retirement.

And the bad news: Millennials are not investing nearly enough of their retirement savings in the stock market.

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The Millenial's key to a secure retirement. Source: TaxCredits.net.

Many young retirement-savers are being overly cautious when it comes to the stock market.

In a recent Wells Fargo survey studying the savings habits of Millennials, only 59% said the stock market was the best place to invest their retirement funds. That means many Millennials are robbing themselves of the best asset a young investor has: time. By not fully investing in the stock market when their time horizon is the longest -- in some cases, between 40 and 50 years -- Millennials stand to lose out on hundreds of thousands of dollars in their personal retirement accounts.

The survey found that only 18% of respondents reported being 100% invested in stocks (or mutual funds). The survey also found:

  • 26% of respondents said they were partially invested in stocks (50%-75% of their portfolio).
  • 30% said they were minimally invested in stocks (25% or less).
  • 25% were "not sure" what they were invested in.

While it's true that the stock market can be a risky place, the bottom line is that there is no better investment for a young saver armed with decades of time.

Time: A stock investor's best friend
For a young investor, an excessively conservative portfolio that does not maximize stock exposure is a sure recipe for self-sabotage. Here's why.

In rolling 20- and 30-year periods, the stock market has never posted a net loss -- not even during the Great Depression. Additionally, stocks beat bonds every single time over 30-year periods. While past performance is no guarantee, it can help investors understand what kind of risks are reasonable. Knowing that there has been no historical span of time greater than 20 years when the market posted a loss, and stocks outperform bonds in the long term, isn't it a greater risk not to be fully invested in the stock market when you have time on your side?

Still not convinced? Try this: The market has historically returned about 9% annually. So let's say you contributed $2,500 per year to a Roth IRA starting at age 25. At that rate of return, you would have more than $840,000 in tax-free retirement savings at age 65. Bump that savings rate up to the $5,500 maximum, and you'd have $1.9 million at age 65.

Now let's say you only earn a 5% return because, like 30% of the survey respondents, you were only 25% invested in stocks. That same $2,500 invested annually in a Roth IRA would mature to little more than $300,000 -- a difference of over $500,000.

That's more than half a million reasons you should be 100% invested in the stock market if you have more than 30 years until you will use your retirement money.

What should I buy?
With so many options and conflicting opinions, many young investors are confused about what they should buy. Exchange-traded funds, or ETFs, are a great choice for young investors because:

  • The fees are low compared to those of actively managed funds.
  • They generally perform better than actively managed funds (largely because of lower fees).
  • ETFs spread your money across many equities, granting instant diversification and thereby lowering risk.
  • They are easy to buy and have a lower minimum purchase than similar mutual funds.

There are thousands of ETFs to choose from, but here are some best bets for young investors.

Vanguard Total Stock Market ETF (NYSEMKT:VTI)
The name says it all. While this fund is heavy in large caps, it also provides a little bit of exposure to mid caps, at 19%, and small caps, at about 10%. This well-diversified market exposure is an excellent basis for a long-term portfolio.

Vanguard S&P 500 ETF (NYSEMKT:VOO)
This fund is heavier in U.S. large-cap stocks than the Total Stock Market ETF. Large-cap stocks are generally less volatile than mid-cap and small-cap stocks, which can be a comfort for first-time investors.

Schwab U.S. Mid-Cap ETF (NYSEMKT:SCHM)
A general rule of the market is that the smaller the market capitalization, the larger the swings in value. However, while small-cap and mid-cap stocks are more volatile than large-cap stocks, the rewards are greater as well. This fund is almost a pure mid-cap fund, with 93% of assets allocated to mid-cap stocks. Because you have time on your side, there's little reason not to make a mid-cap or small-cap ETF your first purchase and aim to hold it for decades.

Each of these funds has nearly 100% stock exposure and can provide a strong foundation for a portfolio that will provide maximum returns over the long run.

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Melinda Melendez has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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