Something's wrong with the retirement nest eggs of millennials. If they have portfolios at all, too many of them look like those of their parents and grandparents--not in the amount of money they hold but in how conservatively they're invested.
Despite a spectacular advance that has seen the U.S. stock market more than triple since March of 2009, surveys show that many younger people are reluctant to own stocks, including in their 401(k) retirement plans. That means they've missed out on the market's huge gains. A survey done by the
Why have the young shied away from stocks? Some experts say the severity of the 2007-09 market crash, mistrust of
Here are 10 reasons millennials need to be in stocks for the long haul, despite what they may think.
1) You've Got a Lot of Living to Do
You're young, adventurous and have big dreams. Don't wimp out when it comes to investing.
Time is the stock investor's greatest ally. And if you're young, time is the one thing you have plenty of. Ask 65-year-olds what they wish they had done differently at age 25, and many will say they should have invested. The more time you have, the greater the potential for a diversified stock portfolio to blossom and for business success stories (such as Apple) to more than make up for the inevitable failures (such as
Time provides another advantage. The economy fluctuates between growth and contraction. Likewise, stock prices rise and fall. (Hey, that's capitalism!) But when you invest in stocks on a regular basis, as you would through a 401(k) plan, the amount you invest buys more shares when prices are low and fewer shares when prices are high. This is "dollar-cost averaging," and it's a proven way to accumulate stock wealth. And it's why millennials should hope for, not dread, stock market pullbacks at this stage of life. Remember: The goal is to buy low and sell high. Bear markets are your friends.
2) Bonds: Great for Grandpa, a Bummer for You
Interest rates are very low and may stay that way for years. If they do, bonds, cash and similar conservative investments will continue to produce scant returns.
You may keep hearing, though, that the Federal Reserve wants to start raising interest rates. It does, but it's waiting for the economy to start growing at a healthier pace. Earlier this year, it looked as if the Fed would begin lifting its benchmark short-term rate in June from the near-zero level it has held since the financial crisis. But the U.S. economy struggled again in the first quarter, and now most experts believe the Fed will delay any increase until at least September. And even when the central bank begins pushing rates up, it's likely to move slowly--"one and done" is one popular prediction among Fed watchers. The point is that investors hoping to earn high-single-digit yields again on bank savings or bonds may wait in vain. Also note that bonds may not be as safe as you think: When market interest rates rise, fixed-rate bonds typically drop in value.
3) A Silent Thief Stalks Your Savings
This thing called inflation will quietly pilfer your nest egg. Inflation, like interest rates, is low right now, at least as the government officially measures prices in the economy. But any level of inflation erodes the purchasing power of your money over time. Say your cost of living increases just 2% a year for the next 10 years. That would mean that you'll need
Gold and other commodities are known as inflation hedges. But stocks also have done a good job of beating inflation over time. Why? Because stocks give you part ownership of a business, and if inflation is pushing up prices of things across the board, the value of many businesses (land, equipment, ideas and so on) will rise, too. Also, as their costs increase, companies seek to raise the prices of their own goods or services. But it's also true that stocks can be a poor hedge when inflation is rising rapidly in the short term, driving interest rates up as well. The good news is that the sweet spot for stocks as a hedge is when inflation is low and stable--the situation we're in now.
4) You Need a Raise
Everybody knows wages aren't rising much. It has been a different story with dividends. As companies grow and generate bigger profits, they often reward shareholders by raising their cash dividend payments. That puts more money directly in shareholders' pockets each year, or allows them to put the cash toward buying additional shares. Record corporate earnings have translated into robust dividend growth in recent years. The annualized dividend rate on Standard & Poor's 500-stock index, which tracks mostly large, mostly U.S.-based companies, has jumped 67% since 2009. Not many people can say the same for their salaries.
Consider: Diversified manufacturer
5) Uncle Sam Has a Soft Spot for Stocks
What's more, if your stocks appreciate over time, when you eventually sell, the maximum capital gains tax rate is the same as the dividend tax rate for most people: 0% or 15%. That means you keep most or all of any long-term gain. Bonds, too, can provide capital gains if market interest rates fall. But with rates already so low, the potential for large capital gains on bonds is limited.
6) Two Words: Basic Diversification
Smart investing starts with admitting that you can't predict the future--and that you shouldn't try. An investor survey done by the
Tarbox says younger people understandably may be intimidated by financial markets and fear that investing is too complicated for them to grasp. Yet history shows that successful investing is rooted in "a few simple lessons that keep coming up," she says. First among them is basic diversification.
7) Everybody Deserves a Piece of the Pie
Stocks give you a direct stake in the economy. When you own shares in a company, you legally own a slice of that business and therefore a slice of the economy. If the economy grows and your company grows with it, the stock price should increase over time as well. Along the way, many companies directly share profits with their investors by paying them regular cash dividends that also can increase with time. By contrast, you can't participate in economic growth by owning bonds or a bank account. They pay you a fixed rate of interest, and no more--regardless of how well the company issuing the bond performs or how profitable the bank becomes.
Of course, with stocks the potential for growth also comes with the risk of loss if the company, the economy or both stumble. That's the trade-off. But over long periods, the payoff from stocks has been substantial. One of the easiest ways to own a broad-based piece of the economy is via a diversified "index" fund, such as one that is designed to mimic the performance of Standard & Poor's 500-stock index, which consists of 500 mostly large, mostly U.S.-based businesses. From the start of 1926 through
8) Investing Is Like Kickstarter, but With Rewards
You never know what kind of amazing business ideas are about to explode onto the scene. These are exciting times in so many industries, from tech to health care to transportation. What will be the next
(See the 15 Best Stocks of the 21st Century for more.)
Investing also allows you to make a statement with your money--for example, by owning shares of companies involved in green energy or those that pledge social responsibility. It's admirable that people send money to entrepreneurs on funding Web sites such as Kickstarter. But those entrepreneurs have no obligation to repay their financiers. On the other hand, investing in stock helps support a business and makes you a direct beneficiary if the business succeeds.
9) Investing Abroad May Help Your Money Grow, Too
Stocks give you a way to search the planet for opportunity. With the Internet, the world has never been more connected and business has never been more global. Likewise, investing abroad is simple via mutual funds, exchange-traded funds and individual stocks. Investing abroad also carries special risks, however. One is geopolitical risk--say, the overthrow of the government in a nation where you invest. Another is currency risk: If you own stocks in a country whose currency is depreciating versus the dollar, the value of your shares will also depreciate.
Over the past five years, foreign stocks overall have been duds for U.S. investors compared with domestic shares. During that period, the typical mutual fund that invests in a diversified bundle of large-company foreign stocks gained 6.9% per year on average, and the typical diversified emerging-markets stock fund earned just 2.6% annualized. By contrast, the mutual funds that focus on large U.S. companies returned an average of 12.9% per year (figures are through
10) You Can Make Wall Street Work for You
It's OK to distrust
As for costs, as recently as
But the biggest benefit for small investors, particularly young ones, may be the rise of 401(k) plans, IRAs and other retirement accounts, which provide immediate tax savings and allow your assets to grow tax-free until you begin pulling the money out. Or consider a Roth IRA or, if available through your employer, a Roth 401(k). These retirement-savings plans don't provide an immediate tax break, but they do let you withdraw money tax-free in retirement.
If you aren't sure which funds to buy in your savings plan, consider a so-called target-date fund, a one-stop solution that holds stocks and bonds and is designed to match the mix with your retirement date. Pick the fund whose name includes the year closest to your expected retirement date, presumably 2055 or later. Over time (but not for a while), the fund will gradually trim the amount it has in stocks, becoming more conservative as retirement approaches.
What's important is that you get started, even if you do so with just modest sums. And remember: If your employer matches the contributions you make to an account, failing to participate is like leaving free money on the table. Why on earth would you turn down free cash?
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Tom Petruno is a Contributing Writer at Kiplinger's Personal Finance.