Recent studies have shown that Millennials are doing much better than previous generations when it comes to saving money and living within their means. One survey found that 70% of millennials with full-time jobs started saving for retirement by 22 years of age, much improved from Generation X-ers and Baby Boomers, who started saving at ages 27 and 35, respectively, on average.
However, even though they're saving money for the future, many millennials are afraid to take any sort of risk with their savings. This eliminates the effectiveness of the most powerful investment weapon of all -- time.
The mindset of many millenials
The definition of a millennial varies somewhat, but is generally accepted to mean those Americans from around 22 to 35 years of age, or the adults in the workforce born after 1980. This is a group of people who spent some of their college or early working years observing the effects of the financial crisis.
Some had parents who lost a house or job, and saw firsthand the devastating potential effects of inadequate saving, living beyond one's means, and borrowing too much money. In fact, a Wells Fargo study found that 80% of millennials say the recession taught them the importance of saving money now.
And, many were left with a general distrust of the stock market after having watched many people lose their savings, as companies imploded during the crisis years. It should come as no surprise, then, that one of the biggest misconceptions among millennial investors is considering that the word "risk" as an inherently bad term.
One study revealed that those ages 22 to 32 chose to put 75% of their retirement savings in cash and fixed-income assets. So, while they save well, millennials are hesitant to put any of their money into stocks, with a lot of younger adults choosing to invest in lower-risk, but lower-reward, investments.
Why this is bad
Many millenials just happened to get started at exactly the wrong time. Some years, the market will go up, and some years it will go down; but over any long period of time, stocks outperform any other asset class. However, when an investing career starts with volatility and recession, that person may develop a skewed perception.
And, just like anything else, there's a right way and a wrong way to buy stocks. With some good diversification and risk-mitigation strategies, such as buying only low-volatility dividend growth stocks, index funds, and blue chip companies, stocks can create an excellent stream of income and growth that can produce some amazing results over time.
Consider a millennial just entering the workforce who begins saving $500 per month. Savings accounts pay very little interest, so we'll assume the national average of 0.10% per year. The highest-quality investment-grade corporate bonds pay around 4.3% per year (for 20+ year maturations), so we'll use that in our calculations. And, during the past 20 years, even including the tech crash and the financial crisis, the S&P 500 has averaged total returns of 9.3% per year.
As you can see from the chart below, the difference is not too noticeable after just a few years. However, over a 30-year time period, the differences in the returns from each of the three types of investments is dramatic. The savings account would be worth about $182,600, the fixed-income investment would end at just less than $354,000, and the stock portfolio would grow to $865,000, or almost five times the value of the savings account. That's why it's important to rebuild millennials' trust in the market, and get them to invest their savings wisely.
Some solid investing habits could solve the "retirement crisis"
There has been a lot of coverage in the media claiming that a "retirement crisis" is coming due to the uncertainty surrounding Social Security, and the low retirement savings rate among Americans. In fact, one-third of Americans between the ages of 30 and 49 have absolutely nothing saved for retirement. These claims of an impending crisis do have some merit. After all, if Social Security were to be drastically cut, people with no other retirement savings wouldn't have a whole lot of options.
Millennials have already taken a step in the right direction by becoming better savers. Now, with some progress toward a sound investment strategy, the younger generation of American workers could put themselves on the right path toward a more sound financial future no matter what happens with Social Security.
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