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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