According to an April survey from national pollster Gallup, just 52% of Americans owned stocks, which matched the lowest rate of stock ownership in the 19 years that Gallup has conducted its survey. By comparison, a record high number of Americans (65%) owned stock in 2007, just prior to the Great Recession.
Why Americans avoid the stock market
You may be wondering: Why are stock-ownership statistics so dismal? A lot of it could have to do with two major swoons in the stock market since the turn of the century. The broad-based S&P 500 (SNPINDEX:^GSPC) wound up tumbling approximately 50% when the dot-com bubble burst, and another 57% when the Great Recession hit. Those two massive drops are still fresh in the minds of risk-averse Americans, keeping many from re-entering the stock market.
The other issue is that most Americans have a negative view of Wall Street. The latest Bloomberg National Poll, released in July, showed that 52% of survey-takers had an unfavorable view on Wall Street banks, and 50% had an unfavorable view on corporate executives. Comparatively, just 31% of respondents had a favorable view on both Wall Street banks and corporate executives (the remainder were "not sure"). If Americans don't trust Wall Street, they won't invest. It's that simple.
Furthermore, Gallup's April poll suggests that younger, middle-class Americans are among the most likely to have lost confidence in Wall Street. Since 2007, stock ownership has fallen by 22 percentage points to 50% for those earning between $30,000 and $74,999, while stock ownership dipped 14 percentage points to 38% for those aged 18 to 34.
Understanding the difference between real-money and nominal gains
So, where are the 48% who aren't investing in stocks putting their money? A lot are simply keeping it locked away in a savings account, earning interest, or perhaps they're counting on their home to appreciate in value. Unfortunately, for folks who aren't investing in stocks, the chances of making any real money now are pretty slim.
It all starts with understanding the difference between nominal gains and real-money gains. A nominal gain simply describes the money you've earned on an investment. If you have $10,000 in a bank savings account that yields 0.25%, you'll earn $25 in interest this year. That $25 represents your nominal gain from your investment.
Real-money returns take into account what your gain looks like when you factor in the rate of inflation. Inflation describes the magnitude of price increases in a predetermined basket of goods and services. The Federal Reserve usually targets a national inflation rate of 2%, but lately the actual inflation rate has been hovering a tad below 2%. Nevertheless, if the average cost of goods and services is increasing by 1.7% or 2% a year, then you'll need your investments to yield a return of 1.7% or 2% a year just to keep pace. With a lower nominal gain, you'll lose real money. In our example above, the 0.25% yield would still be losing well over 1% in real money based on the current inflation rate.
Risk-averse young adults today face a dilemma: settle for a low rate in the name of safety or choose assets they perceive as very risky. Young investors need to be willing to invest in assets that can yield real-money gains, but they're too afraid to move from assets that lead to near-guaranteed nominal gains, such as bank CDs, savings accounts, and bonds. But the safer an asset is, usually the lower the yield. Right now, bank CDs, savings accounts, and bonds are exceptionally safe, but they're probably not generating real-money gains, and that spells trouble for millennials.
Even relying on a home as a retirement piggy bank isn't a smart solution. Though the past 20 years have witnessed abnormally strong housing price inflation, the 100-year period between 1890 and 1990 saw home prices outperform inflation by an average of 0.21% per year, according to data from Robert Shiller in his book Irrational Exuberance. It was even worse between 1950 and 1997, when home prices topped the inflation rate by a meager 0.08% annually. A primary home is generally not a good investment.
Why you need stocks in your investment portfolio
If millennials, or any investors for that matter, hope to really compound their wealth in the decades to come, they're going to need to come to terms with the fact that the stock market is the greatest long-term wealth creator.
Historically, the stock market has returned 7% a year, inclusive of dividend reinvestment. Even with a long-term inflation rate of more than 3%, we're still talking about a real-money return that has averaged around 4% a year. Utilizing Bankrate's return on investment calculator, I entered the following criteria:
- a 7% rate of return over 40 years
- weekly investments of $100
- a 3% inflation rate
The result? Following this strategy, our fictitious individual would have $1.24 million at retirement.
Furthermore, despite the inevitable corrections that occur in the stock market, optimistic investors seemingly always come out ahead. Since Jan. 1, 1950, there have been 35 corrections of at least 10%, when rounded to the nearest whole number, in the S&P 500. In all 35 instances, the move lower in the index has been completely put in the rearview mirror by a bull market rally. Be it weeks, months, or in rarer cases years, the data suggests that high-quality companies tend to increase in value over time. In other words, if you buy high-quality stocks and hang on to them for a long period of time, you should do just fine and generate real-money gains.
Still too scared to invest in individual stocks? Why not try diversifying across hundreds or thousands of stocks by choosing an ETF. For example, the Vanguard S&P Small Cap 600 ETF (NYSEMKT:VIOO) is an index fund that closely tracks an index that attempts to mirror the performance of around 600 small-cap companies. Small-cap stocks should be especially intriguing for younger investors since they're often higher-growth companies. With the fund's diversity and an exceptionally low annual expense ratio of 0.15%, you won't have to worry about your money disappearing overnight. Plus, the Vanguard S&P Small Cap ETF has outperformed the S&P 500 by 28 percentage points since its inception in 2010.
It's time to put Wall Street distrust and short-term fears aside, and trust a trend that's persisted for more than a century.