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Getting Millennials Financially Fit?

By Clay Baker & Mikael Rudolfsen - Crystal Waters Capital October 2019

If you're not working on investing for retirement...you're already late

Retirement! I'm just getting my life started.


The Millennial generation is now the single largest generational group in the US, let alone the world, and face unprecedented wealth-creation opportunities, but also generational legacy challenges as many have inherited a dose of skepticism and fear of investing from their Baby Boomer parents who struggled to deal with financial markets despite a healthy economy.


Despite enjoying several decades of expanding economies and a booming stock market, Baby Boomers suffered through several significant market downturns each decade scaring many, either completely or partially, out of the market causing them to miss out on some of the biggest wealth creation opportunities in history, creating a significant inter-generational wealth gap which should be a road-map for Millennials.


Over the next decade or two, Millennials stand to inherit roughly $68-$75 trillion from their Baby Boomer parents

This is an unprecedented amount of wealth (roughly three times the national deficit), which may make many believe the Millennial generation is financially set. However, as Baby Boomers live longer into retirement and politicians seek to pay for new large-scale initiatives around healthcare, defense, education, and the environment, politicians are counting on to provide the lions share funding for ongoing social security, medicare, and many new expensive policies, in addition to saving for their own retirement. This means they have a large burden to not only preserve but substantially grow their share of the wealth transfer. As bond yields decline and volatility increases, fixed income provide a far less attractive risk-adjusted rate of return, and Millennials need to look to the stock market for a diversified and tax-efficient way of growing the wealth that is coming to them or they will become the largest generation in history to be unprepared for their own future and retirement.


A generation with massive impact

If you were born between 1980 and 1998 you're considered part of the Millennial generation. You are 21-38 years old and are part of the biggest demographic shift in U.S history with enormous implications for the economy and investors. Think Baby Boomer parents had a big impact on society and the planet? They have nothing on what impact Millennials have right now and will continue to have for the next few decades.


Millennials and previous generations aren't the same

When it comes to investing, retirement, and saving for future events, Millennials and baby boomers couldn't be more different. From an earnings perspective, Millennials are just getting started in a stage of life where they will earn more than at any other stage of life. While retirement may not be front and center for them right now, saving and investing for this inevitable stage of life is critical. Never before in the history of America has one generation faced these mega-trends where economics, wealth transfer, geopolitics, tax policy, and interest rates, converged into a perfect storm of potential wealth creation.


Start earlier, time is not your friend

Starting early is advice that every financial planner hands out, and 20, 30 or 40 years down the road the recipient of that advice decides it’s time to start saving. All of these late starters end up wishing that hindsight wasn’t their teacher. Because of the power of compounding, starting early, even with small amounts of money, can lead to tremendous growth over long periods of time. But that's not all we're focused on here. While the millennial generation has opportunities for wealth creation unlike anything seen before, the challenge for many Millennials is that they are going to find themselves with an extraordinary expense that's probably never crossed their mind.

"Hindsight is the cruelest university to attend. The charge for the education is double what it was worth, while foresight was offered for free" - Clay Baker

What's ahead for Millennials?

Millennials are a unique generation in terms of the wealth that’s coming to them, but also the financial challenges and burdens that lie ahead of them. They stand to benefit from the largest generational wealth transfer ever with transformative technology continuing to drive innovation and growth across all sectors of the economy. However, Baby Boomers are living longer, putting a strain on the younger generation to financially keep social security and the growing cost of the healthcare system going. As new large healthcare, defense, educational, and environmental initiatives increasingly become political priorities, Millennials will likely carry the majority of the financial burden through direct and indirect taxation.


What are the big trends facing Millennials?

To prepare for the financial events over the next few years as well as the ones 20-30 years down the road, Millennials need to understand the big picture of their own demographics, and the inevitable trends that will unfold. To better understand what is ahead for Millennials from a financial standpoint, it’s important to understand what the Baby Boomer generation went through. Not because it will be the same, but because it will likely be very different. You may not have been looking for a history lesson, but this one hits a whole generation in the wallet, so it’s worth learning.


The Baby Boomer Precedent

The term "baby boom" most often refers to the post–World War II baby boom (1946–1964) when the number of annual births exceeded 2 per 100 women (or approximately 1% of the total population size). There are an estimated 78.3 million Americans who were born during this period. Their numbers peaked and have been decreasing since 1999 and today Boomers number about 73 million. Boomers have a few things in common; they lived through the Korean War, Kennedy-family assassinations, Cuban Missile Crisis, Vietnam, 1960's and 1970's political unrest, 21% interest rates and the energy crisis of the 1970s while living longer than their parents did. They also enjoyed one of the longest economic expansions and stock market booms with the S&P 500 returning over 1,800%, or around 7.5% compounded annually.


Boomers - The challenge of staying invested

Few people earn enough money from their job alone to last them through retirement, and most need to grow their savings through long-term investing. Investing is not an episodic event but rather a continuous effort of owning debt and equity of companies where hundreds of relatively small gains add up to tremendous aggregate gains over time. Bumps in the road and setbacks are par for the course, but over the long run the direction is up and patient investors do well.

“The stock market is a device for transferring money from the impatient to the patient” -Warren Buffet

Despite a brief decline in the early 1970's, Baby Boomers enjoyed a steadily increasing market throughout the 1960's, 70's, and early '80s. However, on October 19th, 1987, a number of unrelated events conspired to tank global markets on a single day, known as Black Monday, with the Dow dropping 508 points or 22.6% in a single day. Seeing a substantial portion of their investments and wealth vanish before their eyes, many people simply pulled most of their assets out of the market, missing a massive rally and wealth accumulation during the 1990's. Then they were scared out of investing again during the dot-com crash from 2000-2004, and again most were hit exceptionally hard by the Great Recession and the financial crisis that followed in 2007-2009. To make matters worse, medical expenses increased at abnormally high rates and housing prices returned to overly inflated levels over the past two decades adding insult to injury for people who did not stay invested and simply tried to keep up through savings.


Behavioral psychology has proven that negative events have a far greater impact on people than positive ones. A single adverse instance can override years of positive ones, and when markets go south, even just temporarily, investors are often so scarred, disgusted, or both that they abandon the effort, despite historical gains and the promise of future growth. While Boomers experienced unusual prosperity, they also endured some financially painful events which greatly tested their commitment to their retirement investments. However, many Boomers had something that help them stay the course - shares of stock and reliable dividends in the company where they worked, even if their employer was a smaller company. This played a big role in boosting the wealth of the middle-class.


One of the key reasons so many companies offered shares to employees and automatically got the investment process going for them was that we used to have many more public companies. Prior to 2000, the majority of initial public offerings (IPO's) were companies with sales of less than $50 million. When these small companies wanted to grow they could seek capital through the public markets. To attract and retain great employees the companies would issue stock to employees either through options or retirement accounts. The result was the rank and file employees also benefited through these company stock programs where they could accumulate shares and generate savings and income from the dividends without having to think about the investment process too much. When the stock market wobbled, most people at least remained invested through their employer. But after the dot-com bubble burst, Congress put an end to all that, presumably for our own protection. The new regulations made an IPO possible only for much larger companies, removing any possibility that a smaller company could go to the public markets for capital. Instead, small companies, who as a group remain the largest employer in the country, are now forced to seek capital through banks or simply remain small. The new regulations worked. Small-company IPO's declined dramatically after the regulations expanded from 2001-2010, and the number of public companies overall has declined significantly as seen below.

As the number of publicly traded companies have declined, the market cap of these companies has increased dramatically.


To make matters worse, the decline in small company IPO's also dramatically reduced job creation as small companies with access to capital tended to grow rapidly and hire more people. In a report produced by the SEC in 2012, a sample of 1,245 U.S Emerging Growth Company IPO's from June 1996 to December 2010, found that pre-IPO Employment was 437,934 job. Employment at these companies 10-year after the IPO was a stunning 1,142,200 jobs; a 160.8% increase in jobs. ( Source: Post-IPO Employment and Revenue Growth for U.S. IPOs, June 1996-2010 Kauffman Foundation Report by Martin Kenney, Donald Patton, and Jay R. Ritter ).


Boomers - Social Security and Medicare

In 2017 there were 49.2 million retirees in the U.S, with 10,000 more joining them every day. Due to health issues and job losses during the Great Recession, and a rising population of Millennials, boomers are retiring at a mean age of 63 instead of the traditional 65 and older. With all the talk of raising the retirement age in order to preserve social security a bit longer and reduce the number of Medicare recipients; the data doesn't support that this is really possible. At least not without serious side effects. The data also doesn't support that Millennials can afford the "Medicare for all" plans or most of the other programs being discussed at the current political level [4]. As currently proposed, Medicare For All is estimated to cost each taxpayer roughly $21,000 and an annual cost of $3 Trillion dollars.[7] Maybe there's a better way.


Boomers’ parents were continually being scared out of investing in the markets and on top of that had their savings eroded by artificially low-interest rates. The result is born out by the 2018 Retirement Confidence Survey which found that 45% of workers have household savings and investments of less than $25,000. The Bureau of Labor Statistics says that adults 65 and older, spend on average, $48,885 per year. Social Security is not going to fill that gap, and only 16% of those retiring have enough to fund their retirement years, leaving 84% of the retiring population seriously short on money. Millennials and GenZ are going to be filling that gap to support their parents through retirement. How painful or easy this depends on the decisions they make right now.


Retirement - How did we get here?

Access to better healthcare and a move from farms to cities had a dramatic impact on life expectancy and in fact, played a key role in the creation of the concept of retirement.

Retirement is a generational event that's been different for every generation. Prior to the 18th century, the average life expectancy was 26 to 40 years old, hardly long enough for many to even consider a period of life where they would need to support themselves without a job.


In the mid-1800's certain United States municipal employees, including firefighters, police, and teachers, started receiving public pensions. In 1875, the American Express Company began to offer private pensions. By the 1920s, a variety of American industries, from railroads to oil to banking, began offering pensions.[1]


By 1935, a widespread idea emerged, pay older individuals enough to quit working. A Californian, Francis Townsend, proposed a plan offering compulsory retirement at age 60. In return, the Legislature would pay benefits of up to $200 a month. In response to this, President Franklin D. Roosevelt proposed the Social Security Act of 1935, which made workers pay for their own retirement through taxation.[2] In short, the nation saw jobs as a finite resource and was looking for a way to open up those finite jobs and keep younger workers employed, while at the same time not allow older citizens to fall into financial ruin.

In the early 1970s, a group of high-earning individuals from Kodak approached Congress to allow a part of their salary to be invested in the stock market and thus be exempt from income taxes.


This resulted in section 401(k) being inserted in the taxation regulations that allowed this to be done. What the Kodak employees and politicians didn't count on was that the new 401K would lead to the elimination of corporate pension plans and would turn over the daunting task and all responsibility for employees to figure out how to save for their own retirement. A whole industry emerged to capture individual retirement dollars and to create 401K plans for companies too small to manage them on their own.


As pensions disappeared and boomers worked to figure out how to save for retirement, inflation soared, especially during the 1970s. Retirement plans were silently eroded by inflation as the cost of living soared past what could be earned. Advisers pitching security and income generation got boomers into bonds. U.S. Government bonds were paying fantastic rates and provided a risk-free way to save for the future; you just had to be willing to lock up your money for 2, 5, 7, or 10-years at a time. Some did, some didn't. Investors who were early savers starting in the 1950s or 1960s did okay for those first 10-20 years. U.S Bonds started from a low of 1.9% in 1951 and climbed to a high of nearly 15% by 1981[3]. For most of this time bonds outperformed stocks with lower risk. It was during this time that the 60/40 investment portfolio became popular. This is an investment plan that invests 60% in stocks and 40% in bonds. As the investor gets closer to retirement the percentage of bonds would be increased, presumably adding additional income and security while also decreasing risk. But by the end of the century bonds were paying about 7%. In 1999 the inflation rate was 2.21%, so those 7% bond yields were really only delivering 4.79%.


During the 1980's, when many Boomers were still in college or early in their career, they lived through the greatest financial crisis since the great depression, the Savings and Loan crisis, which have shaped financial perspectives and decisions for decades afterward. An act of Congress in 1932 that was designed to promote homeownership (sound familiar) turned into a crisis when interest rates soared during President Carter's administration. To try and solve the underlying problems, Congress passed a series of bills that enabled the Savings & Loans to make riskier loans, invest in speculative real estate and charge much higher rates of interest. It played out as you might have expected. By 1989, more than 1,000 of the nation's savings and loans had failed and many more were in deep trouble from failed loans and risky investments that should never have been made. After years of Congress kicking the can down the road, President George H.W. Bush forced the closure of the failed Savings and Loan banks with a $50 billion bailout [5], but not until many people lost material wealth, walking away with an indelible sense of caution and trepidation about any type of investing. They passed much of this financial stress and perspective on to their millennial children through the conduit of 'Parental Advice'. Many millennials have grown up with an inherited distrust of company stocks and banks, and have been directly warned against financial calamities and investing in the stock market.


Millennial Stats

Millennials are big news — and with good reason: it is an exclusive global club of 1.8 billion people, which accounts for about a quarter of the world’s population. In the U.S alone, there are 89 million people between the ages of 21 and 38. That's 14% larger than their baby boomer parents generation. China has 400 million Millennials - more than the entire population of the United States, and a look around the globe finds that Millennials are a massive group in almost every country. Given the overwhelming size of the generation, Millennials are going to have a dramatic impact on the planet and on the global financial markets.


Interest Rates

It's been said that interest rates are everything - and so too for the Millennials. They may not realize it yet, but interest rates will dictate almost everything they do. If you like a new car and the interest rate is 3%, you might wait. If the dealer offers 0% interest, you're driving it home that day. Home construction and sales have been booming again due to low-interest rates. Interest rates drive our personal and national economy. Interest rates drive global trade and determine where foreign investment will seek a return. Do you have a credit card? You probably know the interest rate by heart. Do you have more than one credit card? You probably know which one has the lowest rate. When the economy is slowing down the Federal Reserve lowers interest rates to increase economic activity. When the economy is running hot, rates are increased to slow it down. If you're trying to save for retirement this teeter-totter game with rates fights you all the time. As Millennials get ready for all the big-ticket life events, interest rates will play a significant role in how they spend their money, but even more importantly, how they invest.


A whole bunch of important life events are happening or just about to happen for Millennials. College graduation, jobs with a salary and benefits, buying a car, getting married, buying a house, having children, and yes, taking care of aging parents. So what's the most important catalyst in all of these events? Interest rates.


Interest rates are abnormally low and are projected to stay that way for a long time. Normal long-term yields on the U.S 10-year Treasury bond are around 4.50%. Today (October 2019), the 10-year is yielding just 1.75%. When interest rates are low, the risk of buying big-ticket items such as a home or a car is significantly reduced. However, saving money in a regular savings account is nearly impossible because the 1% - 2% interest rate paid on savings is less than inflation. At 2% a $10,000 deposit will double to $20,000 in 36 years. Likewise investing in bonds that pay a yield of 1.75% and have no opportunity to increase in value beyond the face value of the bond will require a significant investment to generate a meaningful income during retirement.


Let's go back to the approximately $48,000 a year that the average retiree is spending.

To generate that entire $48,000, you'll need a $2,742,857 investment in 10-year bonds to receive an income of $4,000 per month at a yield of 1.75%.


Who can afford to put aside $2.7 million dollars in order to guarantee an average retirement? Maybe there's a better way. According to Fidelity, the largest holder of 401K investments in the U.S., the median value of a 401K account for a person age 60-69 is just $62,000 [6]. Hardly enough to fund retirement.


Obviously these numbers don't make sense and no one is going to sock away $2.7 million so that they can live on $4,000 a month. In many parts of the country, $4,000 doesn't cover rent. If your parents are living in a senior center, $4,000 is the monthly rent for a studio in a rural community. That’s not even taking into account food, clothing, travel, insurance, utilities, and medical expenses? The bottom line, interest rates dictate how the next generation must invest and save for their own retirement and to supplement the retirement of their parents.


The Great Wealth Transfer

After considering all the challenges that Baby Boomers had financially, they are still the wealthiest generation in U.S History. That may seem to be in conflict with all the data about Boomers and their lack of investing, but keep in mind that the U.S also has the greatest wealth gap since the industrial revolution with two very different populations within the same generation, rich and poor.


All those Boomers who got repeatedly hurt in the stock market and vowed to stay away from it missed out and couldn’t keep up, relegating themselves for the most part to the poor side of the wealth gap. All those small companies that found new regulations made it impossible to go public, also contributed to the wealth gap. While those who were invested in stocks and continued to contribute through good times and bad found their wealth increased. Over a period of decades, we've created two groups; a small group that have significant wealth because their investments continually work to create wealth on top of their income, and a large group who depend entirely on their own ability to earn income.


Over the next 25 years, 45 million Baby Boomer households will transfer $68 Trillion dollars to their children. Some estimates are as high as $75 Trillion. This will mark the greatest generational wealth transfer in history. According to the Investment Company Institute’s 2018 Investment Company Fact Book, U.S. IRA accounts alone held more than $9 trillion dollars at the beginning of 2018. To put this in perspective, the U.S. national debt currently stands at $23 trillion dollars, that's just under one-third of Millennials wealth transfer. While the national debt continues to grow, the $68 trillion boomers have invested is also growing, but at an even greater rate.


Millennials have to make the greatest investment decisions of all time when they go to the polls for the 2020 elections

Millennials will receive the greatest wealth transfer in history, and these figures are not lost on politicians who are eyeing those $68 trillion dollars to fund a lot of their proposed initiatives. The United States is faced with many important initiatives that all come at a great cost and is likely only fully funded by the government significantly taxing the wealth transfer. While the public political dialog is about the wealth gap, the environment, the wealth tax, immigration, and all the other social challenges that politicians say they can solve...if they just have more money, the real issue is that these politicians are not just looking to tax the wealthiest, but are also eyeing the inheritance of Millennials, especially those IRA accounts and any money socked away in stocks as a way to fund large new initiatives.


Millennials have big decisions to make before and in the 2020 elections. This isn't political commentary or a call to vote one way or another, but simply a call to be aware that this polarized political environment could have material effects on people's financial future. Millennials need to be educating themselves about election outcomes, but also what to do in advance of either outcome, is increasingly important as they plan and prepare for retirement. As they stand today, the tax laws surrounding the transfer of an IRA account are tricky. The beneficiaries need to make sure that the transfer of those accounts is done exactly right, or the tax liability will be very painful. There are also ways in which Boomer parents can gradually begin transferring future inheritance to Millennials today. Anyone currently dealing with or planning to deal with an inheritance prior to next year's election should consult with estate attorneys and financial advisors to make sure they do everything correctly, efficiently, and legally.


Everyone has their personal values and different views of what an underfunded or overfunded government looks like. Millennials have a large voice in society, and beyond just casting a vote in the next election, they have the ability to influence the legislative narrative, which could be important as the parameters of new spending initiatives are defined. Beyond staying invested for the future, Millennials can proactively help shape political agendas that directly affect their future if they understand the process and what is at stake.

“Since this is an era when many people are concerned about 'fairness' and 'social justice,' what is your 'fair share' of what someone else has worked for?”― Thomas Sowell senior fellow of the Hoover Institution at Stanford University

The Trends are Changing Investment Strategies

All of the trends discussed above have created an environment where Millennials need to think differently about investing. There are a number of considerations that Millennials need to discuss with their parents and realize that you can't cut your way to prosperity:

  • how old are their boomer parents with respect to retirement?

  • what health issues do they have?

  • are current health conditions stable or will they get more costly over time?

  • where are they living and is that home, city or state affordable during retirement?

  • how much will they need monthly?

  • will there be a shortfall in monthly expenses (how will that be funded)?

  • often seniors plan for their expenses to decrease, the opposite is usually true?


Getting Financially Fit

Hopefully, at this point, it is clear that you need more than a job salary to prepare you financially for everything that is ahead of you, and the earlier you start, the better. Savings, one-time financial windfalls, and other income that isn’t used to feed your family, pay the mortgage, or get you through the daily grind, needs to be invested as soon as possible. Don't try to time the market. Leave your portfolio alone, and let the compounding nature of the markets do its magic to help grow your retirement nest egg exponentially over time.

You can construct an investment portfolio with a variable amount of risk that matches your risk tolerance, but it should still be appropriately diversified to protect against larger than average market draw-downs that can be difficult to recover from and ruin any chance to accomplish your early retirement goal. There are numerous ways to diversify a portfolio, and how you do so should depend on your age, your risk tolerance, your growth and income needs, and your long-term goals. Growth stocks with low beta, strong earnings estimates, positive sales growth, and expected future growth are an excellent way to identify growth stocks for your retirement.


Whether you construct a portfolio yourself, find a fund that does this, or work with an advisor, diversification is an important component of your investment strategy, and the goal should always be to include new assets to your portfolio that provide opportunities for growth while reducing the overall risk of the portfolio.


Depending on your personal situation, a traditional investing approach may not be appropriate. If you're a millennial that will be providing some or all of your parent's retirement funding, you probably need investments that will grow and provide greater income right now. If you're expecting a large inheritance, your investment portfolio will likely focus on preserving wealth through tax-advantageous investments and diversification. But most will fall into that median group where they need to provide some assistance to their parents while also investing in their own future.


Bank of America recently published a report called "The 60/40 Portfolio is Dead"[8]. In a 60/40 portfolio, you buy and hold 60% stocks and 40% bonds, slowly increasing the bond portion as you reach age milestones of 40, 50, 60, 70, etc. Portfolios going forward from where we're at now will look more like a hedged equity portfolio where most of the investments are in stocks with some combination of growth, value and dividend stocks; and the rest in a hedging fund or cash that generates income. The greatest value of this type of portfolio is that it's highly liquid, meaning that anything in there can be turned into cash very quickly.


The basic principle pitched to every holder of every 60/40 portfolio was that the bonds hedge against risks in the stocks, and the stocks grow and hedge against inflation. However, the data clearly shows that this was only true over the last 20 years. Over the last 65 years, the bonds hedging stocks theory didn't hold up. All investors need a new approach and will likely need a professional who can develop a hedged equity portfolio that doesn't rely on bonds.


Footnotes:

  1. How Retirement was Invented

  2. A History of Retirement...

  3. Bond Yields

  4. Cost of political Proposals

  5. Savings and Loan Crisis

  6. Median 401K balance

  7. Medicare for all

  8. 60/40 Portfolio is Dead



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