There have been several media reports about younger investors who are scared to put their money in stocks, but there's some evidence to suggest otherwise. Here's what millennials are doing in their portfolios, and some advice on how millennials can create excellent portfolios that could deliver outstanding returns for decades to come.
What are millennials really doing?
According to Nicole Sherrod, managing director at TD Ameritrade, millennials are doing a good job of saving and investing. "Not only do 38% of our new accounts belong to millennials, but they are investing heavily in individual stocks," she said.
TD Ameritrade's recently completed thinkorswim Challenge, a four-week investing competition among college students, sheds some light into the type of companies millennials have their eye on. Of the 1,600 participants, the five most popular stocks to invest in were:
- Netflix (NASDAQ:NFLX)
- Apple (NASDAQ: AAPL)
- Amazon.com (NASDAQ:AMZN)
- Facebook (NASDAQ:FB)
- Tesla Motors (NASDAQ:TSLA)
This isn't that far off from what TD Ameritrade's entire customer base invests in. Apple is by far the No. 1 holding among all account holders -- in fact, approximately $17 billion worth of Apple stock is held in TD Ameritrade accounts. Facebook is a distant second, followed by General Electric, TD Ameritrade itself, and AT&T.
According to Sherrod, millennials like to invest in companies with visible brands that they see in their everyday lives, which is evident from their top five choices. In addition, millennials are more likely to invest in socially responsible companies -- in fact, 80% of 18- to 32-year-olds say they wouldn't invest in a company they perceive as negative in this regard.
Those companies are great, but ...
Now, all of those companies certainly are excellent businesses with lots of potential. However, a portfolio consisting of Netflix, Apple, Amazon, Facebook, and Tesla isn't exactly diversified, nor is it low-risk. Anyone who follows Netflix has seen firsthand how devastating even a single bad quarter can be, and stocks such as Tesla still have a long way to go before they have a "mature" business.
The reality is that the bulk of millennials' portfolios should be made up of stocks that they probably would consider "boring." I'm talking about the companies with predictable earnings, growing dividends, and stable businesses. Companies such as Johnson & Johnson (NYSE:JNJ) and Procter & Gamble (NYSE:PG) come to mind.
These companies increase their dividends like clockwork, and it may surprise millennials to know that they actually can outperform the market over long periods. Just look at how these "boring" stocks have done over the past 25 years compared with the S&P 500.
The popular misconception is that these stocks are meant for "old people" and income investors -- believe me, I'm in my 30s, and several friends have told me I invest like an old man when I buy tried-and-true stocks such as AT&T and Realty Income. However, these stocks actually make the most sense in younger investors' portfolios, where the power of compound interest can produce incredible wealth over time.
Just to illustrate the point, let's say you're 25 years old and that you invest $5,000 per year for the next 40 years -- a total of $200,000. If you earn an average total return of 10% per year, which is actually less than those "boring" stocks have produced, how much do you think your portfolio will be worth by the time you're 65 and ready to retire -- $500,000, or maybe $1 million?
It may surprise you to know that a 10% rate of return would result in more than $2.4 million. That's why it's so important to build a diverse base of reliable, solid income stocks in your portfolio.
The Foolish bottom line
By all means, if you like Netflix as a company, there's nothing wrong with investing in it. The same goes for the rest of the "it" stocks on millennials' minds. However, keep in mind that investments like this should be a small part of your long-term strategy. People rarely go broke with a portfolio of high-quality stocks that have been consistently profitable for decades, but people do go broke by throwing all of their money after "the next big thing."
In a nutshell -- it's fantastic that millennials are trying to capture the incredible wealth-building power of the stock market. Now we just need to work on building smart portfolios of long-term winners, and the coming retirement crisis we keep hearing about may actually be avoidable.