Young People Avoiding Investing In Record Numbers
| November 3, 2011 | Posted by Roshawn Watson under Uncategorized |
By: Roshawn Watson
Last year, a study indicated that those growing up in the 1930s are 3 times less likely to invest than those who grew up during better economic times. Fast forward eighty years, and we have had a series of economic crises collectively known as The Great Recession. What is the impact of the Great Recession on young investors?
Fear
Lehman Brothers, GM, AIG, Chrysler, and the collapses or bankruptcies of many other known businesses; a dip in the stock market by 38%; and home prices in the toilet all form the basis for recent resistance to investing. According to a recent study by Wells Fargo, twenty-somethings are more likely to save for retirement in CDs rather than investing in stock than any age group. Given the outright hysteria at times, concern is certainly a very reasonable reaction because it is unclear what the future holds. Nonetheless, most will at least admit that we have had one of the weakest economic recoveries in recent memory. Of course, there are persistent rumors of a double-dip recession looming, and the European Debt Crisis is certainly taking its toil on the global markets (IMF agreement with Greece or not). The only thing that appears certain, economically, is the uncertainty. However, that doesn’t stop people from fearing an inevitable demise in our economy.
Simply put, fear is driving young people to make some dangerous decisions regarding investing.
Ignorance
Media pundits love discussing the “Lost Decade” of investing; however, the whole hypothesis make a series of assumptions that apply to a fraction of investors. Let’s consider the data. Fixed-income funds have outpaced stock in the last 10 years; small cap investors (Russell 2000) have had an annualized return of 6.3% and MSCI Emerging Markets Index returned 12.3% annually (as of January 2011). Balance investors (typically 60% stock and 40% bonds) saw a 25% decline in portfolio balance versus the 38% decline over the last 10 years. Also, the Lost Decade hypothesis also assumes you invested all your money as a lump sum at the beginning of 2000 in the Standard and Poor’s 500 and assessed your portfolio value on 12/31/2009; most people invest incrementally rather than all at once. If you invested quarterly rather than plopping down say $50,000 in January 2000 without rebalancing, your annualized return would be 1.16% instead of a -1.25% thanks to dollar cost averaging. Note, rebalancing is realigning your portfolio to asset weights congruent with your original risk tolerance (i.e., the original portfolio weighting). Suppose your portfolio consisted of 20% bonds and 80% stock (i.e., rather than 100% stock), and you rebalanced. If you had, your annualized return would be 2.27% (vs -1.25%). If you added small cap or emerging markets, you would get…well, you get the picture. Also, consider that most people require a longer time horizon for investing (i.e., at least most people take longer than 10 years to invest for their retirements). Even if you went all the way back to post World War II, the S and P still returned an annualized, inflation-adjusted 5.8% as of January 2011. That’s significantly less than the much touted 12% but still whole a lot better than what you would get from many alternatives.
Inexperience
A third reason young investors are not investing in the stock market is inexperience: 1) inexperience with the volatility and 2) inexperience with the implications of NOT investing. While younger investors have the benefit of time, older investors have the advantage of perspective. Historically, there have been prolonged periods of economic growth, interspersed with some adjustments, corrections, and recessions; the stock market has been among the best ways to capture that growth over the long-term. Consider that if you went back World War II, stocks have annualized an inflation-adjusted 5.8%, compared to 1.8% for bonds and 0.4% for cash (as of January 2011). That in itself may instill a level of confidence in older investors that escapes anyone who has just entered the market within the last 10 years, which have been plagued by both the dot com and real estate busts. Additionally, younger investors are less likely to have personally experienced the ramifications of not meeting those retirement goals for themselves. Sure the stories of eating Alpo during retirement are unsettling, but if you haven’t personally been in a situation where you have to choose between paying for your medication or eating, then it’s hard to truly appreciate the risks of NOT investing.
Part of the reason your return is so important is because of taxes and inflation; both erode the value of money in a substantial way. While it is currently anyone’s guess where taxation is going, depending on your income, you currently can be taxed at a significantly higher rate (at the rate of earned income) for interest earned from saving money outside of a retirement account than you would if you had received dividend or capital gains income from a portfolio invested outside of a retirement account (assuming the investments were held a sufficient length of time). Inflation can similarly decimate portfolio, considering that $100,000 today will be worth only $31,000 in 40 years. Note this calculation assumes inflation will return to and remains at its historical average of 3%. In other words, just because the balance in your savings account is not declining does not exempt you from losing significant purchasing power. Making more from your money means you can counterbalance these forces.
Parting Thoughts
The decision to forgo investing in the stock market is not trivial. Those who chose to cash out of the market due to the 2008 crash have missed the gains in the market since then. In no way am I diminishing the complexity and volatility of the times that we live in; however, rather than avoiding the markets outright (whether real estate or stock), perhaps a better strategy is to adopt a more conservative stance: one that is congruent with your current risk tolerance. Personally, I want you to dominate financially and take courage. However, if you fear anything, fear NOT investing.
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I think you have hit the nail on the head twice. Ignorance and inexperience are key factors in how young people are managing their money these days. Sadly their parents haven't given them the tools they need to prepare themselves financially and they are going about things blind. Even many of my friends whom I would think would know better, don't manage their money with the future in mind. It is so frustrating.
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This is the story of the markets. People want to buy financial assets when they are expensive and run in the other direction when they are cheap. Part of the reason is that they don't learn the basics of investing in school. The message that they should invest on a regular basis and hope for a drop in stock prices of 50% is lost on young people. What they should be thinking about is where markets will be 35 to 40 years from now when the size of their nest egg will determine their available choices.
11/14/1972 Dow Jones stood at 1003.16. Today at 11,951! This despite the never ending craziness of the past 50 years.
Young people will jump in at the peak of the next big upturn.
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What a great point regarding Dow in 1972 compared to now, but I would expect no less from an investment advisor and teacher as yourself! We're conditioned to de-emphasize market psychology. So many of us think we're better and smarter than we really are. Our overconfidence in this case is particularly tragic because the stakes for getting it wrong are too large.
My recent post Young People Avoiding Investing In Record Numbers
Great article!
I agree not investing is bad move, history has shown that to be true. It is a lot more complex than it use to be, but now is the time to be in the market instead of out.
I would like to add that it wise to have a decent mix of different asset class investments… ex.) real estate, gold, domestic investments, foreign investments, tulips (lol), and other such assets.
The problem in not investing in the stock market is where do you put your savings? You can put it in your business or income property, but either of those choices is very illiquid. If you need those funds you must borrow or liquidate. Both are bad choices!
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Very good article with excellent insight. It is true that there is likely to be a generation that will be hesitant to invest. I think I might feel the same way if I were coming of age in the past five years. But giving up the great advantage of time is a big mistake.
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Absolutely Don. For most of us "non-sophisticated" investors, diversification is a great strategy to decrease risk. Even the calculations above highlight your very point… maybe hold the tulips though 🙂
My recent post Young People Avoiding Investing In Record Numbers
I think your point and Don point really go together so well. It certainly doesn't have to be all one or the others, and many people would benefit from a more blended approach (i.e., multiple streams of income from multiple types of investments)
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Welcome, and thank you so much for such a kind compliemnt.
You make the very point that makes me so upset about this issue. Losing the time: for this there is no substitute. Many people are setting themselves up for the regret of not investing!
My recent post Young People Avoiding Investing In Record Numbers
I started purchasing, for the first time in my life at age 28, stock in individual companies in early 2008, while working for a Private Student Loan company. Big mistake. 96.96% loss on a few hundred dollars, fortunately I was smart and gambled with money I really didn't need. But instead of getting scared away when the market tank I started buying heavy into ETF's. I may not be able to follow individual companies, but I sure can follow the whole market.
Financial education was and is nonexistant. Being a Credit Analyst taught me so much about personal finance. I extended it by reading great books like "The Intelligent Investor", great blogs like getrichslowly, and theconsumersit. I have had to figure it out on my own… But ever second i have spent reading learning and trying has absolutely been worth it. You only fear what you don't understand. Unfortunately most people my age and younger know nothing about finance.
These crazy market corrections, and generations of lost income, will continue to happen until we put basic financial education in place at all levels of education. Big 'speculators' wont like it because knowledge among the people will even out the market and reduce the wild swings (which the speculators love so much). Math class should be Personal Finance class in Jr High and High School. Personal finance should be the lens through which the majority of Americans start learning math.
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Jeremy,
I'm so glad that you didn't turn away from investing. It is a fact that this is a very challenging time to invest as you outline. I certainly agree that the paucity of financial education is so dubious, as money influences just about every aspect of our lives. I love the Intelligent Investor and have also frequented the sites that you mention. It is not wasted time because this is your life and legacy we're talking about. The problem is you don't always see the results instantaneously, but you will see them over time with smart investments. I think your suggestion about making math more pragmatic and relevant to personal finance early in the school curriculum is a great one and is being debated on many levels. I haven't heard any arguments from detractors, and I don't know what credible reason we could have for not wanting our children to understand their wallets and accounts.
My recent post Young People Avoiding Investing In Record Numbers
I would say FEAR and IGNORANCE are the biggest ailments plaguing the young. I'm 27 and all my peers seem to think they will be young forever and work forever. There is no since of urgency or planning. Also, most of "us" do not know the benefits of compound interest and having a longer investment time frame.
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Bingo, there's a lack of urgency coupled with a sense of invincibility and ignorance of investing fundmentals. It's a surefire recipe for disaster. It is a sad predictment that people in our age demographic find ourselves in too often. That's why I'm so happy that you are stressing financial literacy and responsibility via your site. It a great way to lead by example!
My recent post Young People Avoiding Investing In Record Numbers
It's too bad. I would say it's mostly due to ignorance, as I was there myself. Sadly, our educational system is focused more on perpetuating an expensive bureaucracy rather than teaching kids the tools they actually need to succeed. Hopefully, bloggers like yourself will help to change the tide. 🙂
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I think pure academics have often different views of success compared with how you or I would define success, with us being in the private sector. Of course, you probably would agree that one big problem with this scenario is most people end up in the private sector and need the necessary tools to win financially. It must be better emphasized as part of the curriculums because these are lost opportunities that have huge and lasting implications!
My recent post Young People Avoiding Investing In Record Numbers
Young people coming of age in this decade might be more than a little cynical about entrusting their money to Wall Street….
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I agree, and I think everyone should be careful entrusting their money with anyone else to handle something so critical. I don't care if someone wants to educate me about investment products and opportunities. However, I want to make my own informed investment decisions since I have a vested interest.
My recent post Young People Avoiding Investing In Record Numbers
It is about perspective and about proper asset allocation. To give a contrarian view, the Nikkei index peaked at almost 40K during the late eighties, but today is hovering at less than 10K. Any japanese investor who focused exclusively in the domestic market during that time would be still waiting today for the market to recover. Had he hedged with some international exposure, things wouldn't be that bad today.
You make some excellent points! The situation today is the reverse and a young investor should be making the most of these times by staying invested.
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I agree. With frequent market corrections, it is a great time to catch some deals if you know what to look for. I completely concur with your asset allocation point: far too many people ignore this simple strategy which has profound effects on your overall return.
My recent post Young People Avoiding Investing In Record Numbers
Its silly not to invest. In 5 or 10 years when the market is on a bull run, young people will start entering right at the peak. Then they'll lose it all in the next recession and lament entering (at the peak) to begin with.
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Kennedi, you make such an interesting point. We do follow predictable patterns. It's really just how we're wired. We often think we're much better investors than we really are. This is why dollar cost averaging is so important: you do buy high sometimes with DCA, but you also buy low too. It removes YOU from the equation in some ways 🙂
My recent post Young People Avoiding Investing In Record Numbers
It's easy to look at the market retrospectively. No one knows what the markets will bring and what companies will fold. Why? Because too many people tote the idea of investing without directing people how to read a financial statement. Speculation. All speculation I tell you, until one takes the time to learn what they are investing in. Nice post.
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Hello Romeo,
Thanks so much for this perspective. I agree that one should not invest in things that he doesn't understand: it's pure folly. Given that the past can yield ideas about what will happen in the future, I think looking at historical data is part of due diligence. Hopefully, the retrospective evaluation will instill a level of confidence in young (and old) investors alike that over the long-term, investing consistently is a good idea. Great comment, and thank you for stopping by!
Cheers!
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Very good article..
thanks for the information.
Anytime. Thanks for stopping, please come back again! Cheers!
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They are scared like most of us. But remember buy on fear
Chris
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