Coming of age during a disastrous decade for stocks is shaping a generation of ultraconservative investors, and they're shunning the equity portfolios of their parents for the hiding places of their great-grandparents.
It's ironic, to say the least. Americans in Generation Y -- definitions vary, but generally those born from 1977 to 1994 -- have grown up with X Games and globalization. They spend their time paragliding in the Alps or snowboarding on half-pipes. They fearlessly dine on mystery meat bought from street vendors in Mongolia and run careers off laptops fired up in Internet cafes in Southeast Asia.
"Holding on to the coping behaviors that you learned in a crisis almost always proves to be a disaster in the long run," said Brad Klontz, a Honolulu psychologist who specializes in money disorders. "It's like soldiers who learn to distance themselves from what's going on around them to cope in a war. If you use those same coping techniques when you return, it will destroy everything else in your life."
It's overly dramatic to say that investing like a scared rabbit could ruin your life. But it could certainly affect your ability to free yourself of the working world anytime before you draw your last breath.
Nothing ventured, nothing gained
Seasoned investors also say it's a shame because young investors could potentially amass a fortune by being aggressive in bad times like these. And they're likely to need a fortune, because of crumbling public and private pension systems that other generations were able to lean on to help support them in their old age.They'll need to rely more on what they can create with their 401(k)s and individual retirement accounts than their parents or grandparents have had to.
Yet scared-rabbit investing is almost all that Klontz is seeing, with 20- and 30-somethings putting their retirement money in bank accounts, Treasurys or gold to simply "preserve" their savings.
Other advisers report much the same. Their youthful clients maintain they're too poor to risk throwing good money after bad. Growth? It's hard to believe in.
When stock values dropped in half amid the mortgage mess, youthful investors fled to the safety of bank deposits.
80% without even a 401(k)?
Of course, whether this anecdotal evidence relays an accurate picture of an entire generation is difficult to know. Getting reliable, up-to-date data on what different generations of investors are doing with their money is tricky because most official data are released years late, and survey data are notoriously inaccurate, said Dallas Salisbury, the president of the Employee Benefit Research Institute in Washington, D.C.One reason: Financial jargon is about as familiar to an ordinary American investor as Punjabi. (What's that, you ask? Exactly.) Ask individuals whether they're invested in money markets or equities, for example, and you're likely to get a wrong answer because they don't know the difference, Salisbury said.
Indeed, when the Transamerica Center for Retirement Studies recently asked members of the cohort it defines as Generation Y -- those born from 1979 to 1986, a narrow slice -- what they were invested in, the largest group (31%) said they didn't know.
Of those who thought they knew, 48% were at least half invested in supersafe vehicles such as cash, bonds and money market accounts. Only 22% were mostly invested in stocks, as most advisers would recommend.
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Fidelity Investments, which compiles data on participants in its own retirement plans, sees less conservatism among Generation Y but concedes that its data reflect a small subset of the population. Only about half of all workers have access to a 401(k) plan, and only about 40% of the 20-somethings who are offered a 401(k) even participate, said Michael Doshier, the vice president of marketing for Fidelity's workplace investing group in Boston.
That leaves roughly 80% of Gen Y members investing outside workplace retirement plans, if at all. And, anecdotally at least, they're saving in bank accounts and similar low-yielding vehicles.
It's a generation that might as well be stuffing its money under the mattress.
"They're spooked," Catherine Collinson, the president of the Transamerica Center, explained of the ultraconservative bent taken by these youthful investors. "It's not just stock valuations but the number of Ponzi schemes that have come out lately. People are naturally rattled."
Risk versus reward
Here's a reality check:Yes, if you invest in a Ponzi scheme like the one Bernard Madoff ran, you're likely to lose everything you invest.
But if you invest in established markets with reputable companies, you can expect to be rewarded for taking measured risk, even if you do have to suffer through some sickening crashes like those in 2000 and 2008.
Despite the recent carnage, investing in stocks or stock mutual funds is not the economic equivalent of risking death by playing in traffic.
It's more like taking a long journey (in your car) on the freeway rather than trying to make it across country via side streets. Yes, people drive more slowly and carefully on those side streets. But it can take you seemingly forever to get where you want to go.
In financial markets, risk is measured by the variability of returns, and some risk is well-rewarded. Small-company stocks are considered very risky because in their worst year they lost 58% of their value, for example, while they gained almost 143% in their best year. But on average, small-company stocks earned 11.67% annually over the 83 years tracked by the market researchers at Ibbotson Associates in Chicago.
Treasury bills, which provide returns similar to those of bank deposits, are considered stupendously safe because they almost never have a money-losing year and are backed by the federal government (like bank deposits). But the return for taking such little risk is pretty paltry, too: about 3.7% on average.
What does that difference in average annual returns mean to a 25-year-old? A vast fortune.
If you invested $250 a month, or $3,000 a year, in bank deposits yielding 3.7% on average, you'd have $275,000 some 40 years later when you wanted to retire. If you invested the same $250 but earned the 11.67% average of small-company stocks, you'd have $2.6 million.
Of course, it wouldn't be wise to put all of your savings into one type of investment. That would make your investment portfolio as extreme (and as likely to cause injury) as your adventure sports.
But if you had a diversified portfolio made up of 70% stocks and 30% bonds -- about right for someone in their late 20s -- you could reasonably expect to earn an average of 8.9% on your money over time, according to Ibbotson. That would land you $1.14 million, according to a simple savings calculator at Bankrate.com.
The real risk
The problem with trying to talk young investors into stocks today is that most people figure that what's happened lately is what's likely to happen in the future, said Hugh Johnson, the chairman and chief investment officer of Johnson Illington Advisors.Today's 20- and 30-somethings have witnessed a miserable market during most, if not all, of their adult lives. But going forward, the opposite is more likely to be true.
Between 1929 and 1932, stocks lost roughly 85% of their value. But, in 1933, prices roared back, soaring nearly 54%. The next year, prices were down slightly again, but in 1935 and 1936, stock prices rocketed 48% and 34%, respectively.
Conversely, the unusually high returns of the 1990s -- stocks gained an average of 18.2% annually during the decade, which is about double their historic average -- set up the following decade of disaster, in which stock prices have slipped 3.6% from the end of 1999 through the end of 2008. If the misery keeps up for another year, this will be the worst decade for stocks in history, according to Ibbotson. The 1930s produced a negative 0.1% return.
That's promising for the future. And it can be particularly beneficial for someone who is just getting started and is willing to take some risk.
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Consider what would have happened to someone who started investing aggressively in 1970 -- the start of last rotten decade for stocks -- and stuck with it for 30 years. Assuming he invested $1,000 a month through thick and thin, he ended the 30-year period with a nest egg valued at $4.03 million.
Had he earned just the long-term average annual return for stocks, he would have had half as much -- about $2.1 million -- in 2000. That's also about what he'd have now, a decade later, if he'd suffered through the Titanic 2000s.
Yes, he'd still be mighty unhappy.
But it's important to know that even after suffering the losses of the past decade, this investor would be far better off than somebody who had kept his money safe in the bank. If he had invested the same amount but earned just 3.7% annually over that 40-year period, he would have $1.1 million.
Depression Generation versus Gen Y
Klontz remembers that his grandfather, who grew up in the Great Depression, became so skittish of financial institutions that he kept his savings in a metal box in the attic. He lived in a trailer and scraped by thanks to a small pension, Klontz recalls. It wasn't a comfortable life.Others recall grandparents covering leftovers with used tinfoil kept in a ball beneath the sink and stashing $5 bills in the pages of their books.
The lesson Klontz learned from watching his grandfather: Frugality is admirable, but fear can be crippling to your wealth.
"Right now, having all your money in CDs and cash seems like a great idea. But financial decisions that are based on emotions are usually the wrong ones," Klontz said. "If we develop a generation of people who are afraid to take risks, they'll miss out on decades of earnings."
