Nearly all Americans share two common goals: to be able to cross the retirement "finish line" on their own terms, and to not worry about running out of money during retirement. But both of these goals could prove to be nothing more than a pipedream for some Americans.
Millennials struggle to save
Take millennials -- adults between the ages of 18 and 34 -- as a good example. According to a GoBankingRates survey conducted in March, a third of all Americans (not just millennials) had $0 saved for retirement, with another 23% possessing less than $10,000 in retirement savings. Comparatively, 42% of millennials hadn't saved a red cent toward retirement, with another 30% possessing less than $10,000. In simpler terms, nearly three-quarters of millennials had $10,000 or less saved for their golden years. That's bad news when time and compounding are the greatest ally of millennials.
What seems to be the issue?
Some millennials may be bogged down by growing student loan debt. The latest statistics show nearly $1.3 trillion in student loan debt spread across some 43 million borrowers. The average graduate in 2016 will walk away with a diploma and $37,112 in student debt, up 6% from 2015. While a college degree is a smart move that'll likely give millennials an opportunity for socioeconomic advancement, the near-term negatives of student loan repayments could be hampering their ability to save when it matters most.
Millennials also have to spend more of their income on housing. According to the U.S. Census Bureau's 2013 American Housing Survey, the median 25-to-29-year-old spends 27% of their income on housing compared to just 21% for the median 45-to-64-year-old American. This leaves millennials with less to set aside for retirement.
Wage stagnation could also be to blame. Data from the Bureau of Labor Statistics, as reported by the Pew Research Center, shows that while nominal wage growth topped 700% between 1964 and 2014, inflation-adjusted wage growth was less than 8% over this 50-year period. Meanwhile, college tuition, medical costs, and a host of other goods and services have outpaced wage growth.
However, based on a newly released analysis by NerdWallet, an even bigger issue could be facing millennials in the years to come.
Could you save 22% of your income?
NerdWallet's latest report focuses on the potential that economic growth following the Great Recession could be lower than expected for years, or decades, to come. Weaker GDP growth could adversely impact stock market returns, pushing its historic 7% return average down to just 5%. In an interview with Martin Small, the head of U.S. iShares for BlackRock, Small opined that "the era of supernormal returns is over."
For its analysis, NerdWallet analyzed the saving needs of a 25-year-old earning $40,000 annually. This figure was chosen since it's the median amount earned by millennials between the ages of 25 and 29 according to the U.S. Census Bureau's 2015 Current Population Survey. NerdWallet also assumed that salaries would grow by 2% annually, and that millennials would be seeking to replace about 80% of their working income during retirement.
Under the current model, which assumes annual stock market returns of 7% a year, the 25-year-old millennial would need to save 13% of their annual income in order to retire by age 67 with $1.69 million. In this scenario the fictitious investor would have socked away $353,000 in nominal income and generated $1.33 million in investment returns over 42 years.
However, NerdWallet observed that if stock market returns dropped off to an average of just 5% annually, millennials would have to save 22% of their annual income to reach the equivalent $1.69 million needed to replace 80% of their income in retirement. In this scenario, the fictitious investor would set aside $584,000 in nominal savings and generate $1.1 million in investment gains by age 67. Overall, this works out to an extra $3,400 needing to be put aside per year, or more than three times what the median 25-to-29-year-old millennial pays in median rent each month.
Trying to save 22% could be a daunting task considering that financial advisors suggest Americans target 15% in annual savings, and the personal household savings rate per the St. Louis Federal Reserve in July 2016 was just 5.7%.
Four actions for millennials to take right now
Saving more and investing wisely is a clear necessity for millennials. Here are a few suggestions millennials should seriously consider implementing in order to reach their retirement goals.
1. Formulate a budget and stick to it
The obvious way for millennials to improve their ability to save is by formulating a budget. Though a majority of millennials are working toward saving money for their retirement, most aren't saving optimally. How do I know? According to a 2013 Gallup survey, just a third of all Americans were formulating and sticking to a detailed monthly budget. Without a detailed budget it's veritably impossible to understand your cash flow; and without this understanding it's tough to adjust your spending and saving habits.
The great news for tech-savvy millennials is that budgeting software can be found entirely online, and in many cases it's free. Putting aside just 30 minutes each month is all it could take to create a working budget and make adjustments that could set you up for a comfortable retirement.
One particularly helpful tool that millennials should consider using is automatic weekly, bi-weekly, or monthly withdrawals from a checking account or payroll to an investment or savings account. Removing the excuse of forgetfulness from the equation ensures that millennials remain accountable for their spending habits.
2. Make use of tax-advantaged tools and so-called "free money"
Secondly, millennials need to think about how to grow their nest egg while giving the least amount of their gains back to the federal government in the form of taxes. The answer can be found in tax-advantaged retirement plans, such as a Traditional IRA, employer-sponsored 401(k), or Roth IRA.
Traditional IRAs and 401(k)s are tax-deferred retirement tools that allow you to reduce your current-year tax liability by the amount of your contribution. IRA contributions in 2016 range from a maximum of $5,500 for persons aged 49 an under to $6,500 for those aged 50 and up. For 401(k)s it's $18,000 for persons 49 and under and $24,000 for seniors aged 50 and up. Be aware that when you begin making withdrawals in retirement, these withdrawals will be federally taxed.
A 401(k) can be a particularly attractive retirement solution if the company you work for matches a percentage of your annual salary. Company matches are done for a variety of reasons, but they're usually designed to help retain talent and set employees up for a comfortable retirement. Company matches are essentially free money, and employees should almost always be contributing enough to at least get the full extent of their company's 401(k) match.
The other option here is the Roth IRA, which has the same contribution limits as a Traditional IRA. Though a Roth doesn't allow for current-year tax breaks, it does allow an accountholders' investment gains to grow tax-free for the life of the account. If you'll probably wind up in a higher tax bracket during retirement than you are now, a Roth IRA is a great retirement tool to consider.
3. Invest wisely
Third, millennials need to be particularly smart with the money they're saving. Specifically, they need to be willing to invest in the stock market.
What makes this matter such a touchy subject is that millennials' baby boomer parents wound up being chased from the stock market during the Great Recession and quite a few missed the ensuing rebound and push to new all-time highs. Some millennials have taken after their parents in that they're seeking savings accounts, CDs, bonds, and other safe places to store their savings. However, these interest-based assets are mostly yielding less than the current inflation rate, meaning investors are actually losing purchasing power over time.
The solution? Trust in high-quality stocks. There are more than 7,000 securities listed on reputable stock exchanges in the U.S. for you to choose from, meaning there's something for everyone.
More importantly, despite 35 stock market corrections of at least 10% since 1950, when rounded to the nearest whole number, all 35 of these corrections have been completely wiped out by bull market rallies within weeks, months, or in rarer cases years. There are no guarantees in the stock market, but rising stock valuations over time seems to be the closest thing you'll get to a guarantee based on this data.
4. Seek financial assistance
Finally, millennials should consider getting a second opinion on their long-term game plan. Whether you're a novice investor or have a Master's degree in Economics, it doesn't hurt to be able to bounce your ideas off of your family, friends, or a financial advisor.
Though using an advisor is unlikely to be free, they may be able to offer investment and saving ideas that you haven't thought of. But keep in mind that no matter who you decide to bounce your ideas off of, the path your retirement takes ultimately rests with your decisions.
Millennials still have time on their side, so it's not time to start panicking yet. However, the deck is looking increasingly stacked against millennials, and they'd be wise to be proactive when it comes to their saving and investing habits before it becomes too late.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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