Atlantic Magazine asserts that Millennials are the “best-educated generation in American history,” with more than a third holding a bachelor’s degree or higher. Nevertheless, they may become the first generation of Americans to be worse off than their parents, with lower incomes, more debt, and higher poverty rates.
To succeed, Millennials will need some major preparation, especially considering the world around them is changing constantly. This article will answer three questions that are critical to the success of every Millennial:
- Which obstacles will this generation face during their careers?
- Who can Millennials trust for financial advice?
- What are the most important, time-tested strategies for building wealth?
Millennials Face Mounting Challenges
The challenges facing young people born between 1976-1996 are unlike those faced by any previous generation. The workplace of this generation has drastically changed from the one encountered by their grandparents and parents:
- Slower Economic Growth. For the working careers of most Millennials (2010-2060), economic growth measured by gross domestic product (GDP) will average 2.08% annually, according to projections by the Organization for Economic Co-operation and Development (OECD). This rate is less than half the rate of GDP growth of 6.86% experienced in the previous half-century (1960-2010) calculated from figures supplied by the Federal Reserve Bank of St. Louis.
- Increased Skill Requirements. Physical work requiring little to no formal training is quickly disappearing as intelligent machines assume more of the tasks formerly done by humans. According to figures compiled by the Brookings Institute, the manufacturing sector’s share of GDP accounted for 12.1% of annual real GDP during the period 1960-2010, while its proportion of the workforce fell from approximately 25% to 8.8%.
- Expanded Workplace Automation. Routine tasks are increasingly becoming mechanized. Some experts found that 47% of workers in America had jobs at high risk of automation. The jobs at risk include taxi and delivery drivers, receptionists, programmers, telemarketers, and accountants.
- Reduced Employee Benefits. Defined contribution retirement plans have replaced defined benefit plans (pensions), while more employers are transferring health care costs to employees in the form of higher insurance premiums, co-pays, and limited coverages.
- Extended Nontraditional Employment. Contract labor is replacing employees as companies seek to lower fixed costs and increase flexibility. One report estimates that more than 40% of the American workforce – 60 million workers – will be self-employed as freelancers, contractors, or temporary employees by 2020.
- Escalated Income Inequality. The historical link between productivity and pay is disappearing, exacerbating the disparity between the “haves” and “have-nots.” In 1970, almost two-thirds of Americans were considered middle class, reflecting the link between productivity and pay between 1948 and 1973. Although productivity has continued to increase, about half of American families were considered “middle class” in 2014, according to the Pew Research Center. Rising income inequality is likely here to stay.
- Fragile Social Programs. The survival of social safety nets, such as Social Security and Medicare is uncertain as Federal and local governments wrestle with unprecedented national debt levels. Simply put, neither Social Security nor Medicare is guaranteed for future beneficiaries without significant changes in the programs.
Eugene Steeple of the Urban Institute predicts that Millennials are likely to experience cuts in benefits for themselves and their children, higher taxes, and reduced government services. This is partially a consequence of financing much of America’s growth and increased standard of living during the last 50 years with borrowed funds. According to Pew Research, most American households are vulnerable to financial disaster:
- Family Income Is Increasingly Volatile. More than 40% of families experience an income gain or drop of more than 25% every two years. While drops and gains have balanced out in recent years (about the same number increasing income as those losing income), only two-thirds of those families suffering a drop recover their previous income level within the next decade.
- Emergency Savings Are Virtually Nonexistent. Most households (75%) lack sufficient emergency funds to replace their income for a 30-day period. The top quarter of households have savings to cover just 52 days of income. Liquidating their investments and retirement funds would increase this to an estimated 98 days of protection. In other words, three-quarters of American families could cover only four months of their income (without selling their homes) if a major economic shock occurred.
- Almost Half of Families Spend More Than They Earn. As a consequence, they are unable to save and rely on borrowing to make ends meet. One in 11 Americans now pays more than 40% of their income on interest and debt repayment.
In addition to an uncertain economic future, Millennials begin their working careers with greater student debt than any previous generation: $16,500 for a 1999 graduate, rising to $37,172 for a 2016 graduate. In other words, the average Millennial graduate is shackled to a $23,000 ball and chain (the average debt for graduates during the period) that will impact retirement savings, homeownership, and the age of marriage and parenthood.
Who Can Millennials Trust for Financial Advice?
Some 2,600 years ago, a slave living in Greece warned his listeners of the consequences of failing to plan for the future. Variations of Aesop’s simple tale of the Ant and the Grasshopper have been passed from one generation to another since. The Book of Ecclesiastes – one of the 24 books of the Torah – contains a similar admonition about a time to plant and a time to harvest. Over the centuries, the words have changed, but the formula for financial security has been consistent: Save today for future security tomorrow.
More than 90% of recent college graduates plan to save regularly, according to the 2016 Millennial Money Mindset Report. However, a study by PwC U.S. found that less than 25% demonstrate basic financial knowledge, 30% regularly overdraw their checking accounts, and only 27% seek professional advice on savings and investment.
Perhaps their reluctance to get advice is caused by too many choices. Millennials are often overwhelmed by the variety and volume of financial information directed to them. Consider that:
- A recent Internet search found more than 229 million sources of investment counsel, each available with a single click.
- Financial advisers seem to reside on every street corner. The Certified Financial Planners Board lists more than 76,717 professionals with the CFP designations in addition to almost 12,000 SEC-registered investment advisers. Also, questions remain about the legal responsibility of many advisers to their clients’ interests above their own.
- The Bureau of Labor Statistics lists almost 386,000 licensed insurance sales agents and 635,000 registered broker representatives with 3,800+ securities firms.
- Financial advice television programming is available 24/7, with hosts like Dave Ramsey, Suze Orman, and Jim Cramer becoming household names. Hundreds of newspapers and magazines employ financial columnists, creating thousands of column-inches in advice each week.
Unfortunately, the advice provided – whatever its source – is often biased, contradictory, and motivated by the self-interest of the adviser. Stock brokers and insurance agents are regularly considered one of the least honest and ethical professions in Gallup polling, ranking slightly higher than politicians and car salespeople.
The 2016 film Money Monster depicts the story of a young investor who follows the investment advice of a financial TV star and loses all of his money. While fiction, Susan Krakow, the creator of Mad Money with Jim Cramer on CNBC, admitted in a Business Insider interview that “[t]here are many shows that get it wrong, and many shows that get it right. If you look, there are disclaimers on these shows. You have to do what’s right for you.”
In other words, all financial advice should come with the warning “caveat emptor” – let the buyer beware.
Golden Principles for Financial Security
While financial advisers often claim that their advice or their choice of investment is best, there is no one-size-fits-all strategy, nor a perfect investment vehicle that is appropriate for everyone. The Securities and Exchange Commission (SEC) explicitly notes that “there is no guarantee that you’ll make money from your investments.”
They recommend that the first step before making any investment is to “sit down and take an honest look at your entire financial situation – especially if you’ve never made a financial plan before.”
Fortunately, there are many roads to financial security. Base your investment strategy on your definition of success, your risk profile, and your investment goals. While the outcome of your choices is never sure, the likelihood of success is greater if you employ the following six principles.
Principle 1: Spend Less Than You Make
During a 2015 Atlantic magazine interview, Dr. Edward Chang, a clinical psychologist at the University of Michigan, commented that optimism – a tendency to believe that the most favorable outcome will prevail – is ingrained in American culture and can lead to unrealistic expectations of the future.
Millennials are especially confident about the future, according to a 2016 Northwestern Mutual study. Almost 9 of 10 believe they will achieve their financial goals, even though two-thirds of them question whether Social Security will be available to them when they retire. Despite their optimism, few have acted to ensure their future security:
- Less than 10% of those between the ages of 18-34 have over $10,000 in savings, about 60% have less than $1,000, and 30% have no savings at all, according to a GOBankingRates survey.
- Only 51% of Millennials are enrolled in an employer-sponsored retirement plan or have an IRA, according to a 2016 poll reported by BenefitsPRO magazine.
- While two-thirds of Millennials forego credit cards, 60% of those with a card maintain a credit balance each month and are more likely to miss payments than other cardholders, according to a Bankrate report.
Carolyn McClanahan, a Certified Financial Planner (CFP) interviewed on CNBC Money, says, “As soon as young people start making money, they tend to start spending it all…The big mistake I see young people make is assuming they can save for the future later. But before you know it, you’re 50, and you don’t have that much time to save for your future.”
Living from paycheck to paycheck, using credit cards to cover emergencies, and expecting a future of higher income and lower expenses is a high-risk gamble that rarely pays off. Whether you’re a millionaire or a pauper, you will eventually go broke if you spend more than you make.
Self-control and a financial plan early in life is the easiest way to build financial security, whatever the future holds. Employing a zero-based budgeting system encourages regular saving, whether creating a liquid fund for emergencies, a home purchase, college education for children, or retirement.
The sharing economy enables people to satisfy their basic needs – even luxuries – at lower costs, whether it is renting, rather than purchasing a home, or relying on ride sharing instead of car ownership.
Principle 2: Avoid Debt
Debt is a brutal taskmaster. In the Old Testament of the Bible, Proverbs warns, “The rich rule over the poor, and the borrower is slave to the lender.” While eschewing all debt is unrealistic for most people, never make the decision to borrow money casually or quickly. Spending money you don’t have is a claim upon your future earnings and always reduces your future options.
Good Debt vs. Bad Debt
While debt is debt whatever its use and should be avoided if possible, using borrowed money to acquire an appreciating asset or create value may be justified, even recommended:
- Buying a Home. Few people have the capital to purchase a home without a mortgage.
- Refinancing High-Interest Debt. Replacing high-interest credit card debt with a bank loan with lower interest is appropriate if you can resist rebuilding your credit card balances.
- Capturing Employer-Matching Funds in Retirement Plans. Taking a short-term loan to maximize a contribution to an employer-matching 401k plan is fiscally astute in most cases. The employer’s match portion doubles the return of the employee contribution.
On the other hand, taking out a loan to buy a luxury or depreciating asset is unwise if the pain of repayment extends past the period of any pleasure derived from the purchase.
Many Millennials borrow money to buy an automobile after graduation. New cars lose almost half their market value in the first three years of ownership, but only 20% to 25% during years four to six.
According to Consumer Reports, a properly maintained automobile can last up to 200,000 miles, or 15 years, without major repair or trouble. Furthermore, buying a certified used car transfers the risk of past, poor maintenance to the dealer or certifying company. All things being equal, buying a three- or four-year-old car for less money rather than the latest model is a good practice.
Total student loan debt ($1.4 trillion) is almost twice as much as the total U.S. credit card debt. 1 in 10 borrowers today is delinquent more than 90 days or has defaulted, adversely affecting the borrower’s credit rating. Repaying debt also drastically reduces the potential retirement funds otherwise available to the borrower.
The penalty in lost savings can amount to hundreds of thousands of dollars. For example, repaying a $23,000 Perkins loan requires 10 years of monthly payments of $243.95 ($29,274 in total). If the same amount were invested in a tax-sheltered, marketed-index fund earning 6% annually, the student would have a balance of $40,178 in 10 years and more than $172,000 in 35 years (with no contributions during the last 25 years).
If you have an outstanding student loan balance, be aware of your repayment obligations and options, and take advantage of any opportunity to reduce or eliminate the debt.
President Trump recently suggested that student borrowers “pay 12.5% of their discretionary income inside a 15-year payment window before being eligible for loan forgiveness,” according to US News. For that reason, Millennials should be sure that their Congressional representatives understand their needs.
Principle 3: Prioritize Your Financial Goals
While it is important to begin saving as early as possible, having health insurance and an emergency cash fund should be your priority.
Sources estimate that large medical bills account for more than 600,000 personal bankruptcies each year. While the Affordable Care Act was expected to reduce costs, the New York Times reported in 2016 that about 20% of people under the age of 65 with health insurance struggled to pay their medical bills.
Younger people tend to be in better health than their elders, but they are not immune to events that can result in significant medical costs:
- Obesity: While Millennials as a group are healthier than previous generations, one in five is obese, according to the 2016 Gallup-Heathway Well-Being Index. In addition to shorter life expectancies, obese Millennials will have significant health care costs over their lifetime.
- Childbirth: In 2013, Truven Health Analytics estimated the cost of normal child delivery at $32,093 and a cesarean birth at $51,125. Medical fees have risen on average 6.8% annually since that time, according to the Milliman Medical Index. Complications can add hundreds of thousands of dollars to the cost.
- Sports Injuries: Overextending your knee joint can rupture your anterior cruciate ligament (ACL), leading to surgery and a bill of $12,600. If you need a total knee replacement, the average cost in the U.S. is $58,300, according to Healthline.
- Disease and Accidents: The average cost of a hospital stay for a person ages 18-44 was $7,200 in 2010, excluding the cost of medical treatment or rehabilitation.
Millennials are less likely to have chronic health care issues, but traumatic injuries can occur anytime and rack up enormous bills. A young person should purchase a high-deductible ($5,000 to $10,000) policy for lower premiums and be prepared to pay out-of-pocket for health care costs up to the deductible.
Emergency Cash Fund
Have you noticed that a shatterproof vase always falls on the only surface hard enough to break it? Or that the legibility of a contract is inversely proportional to its value? Murphy’s Law – if anything can go wrong, it will – applies to financial matters as well. Emergencies happen, so it is best to prepare for them before they occur.
According to Chartered Financial Analyst Ben Carlson, the U.S. economy has experienced five significant recessions since 1980, each lasting six months or longer (the average length is 11 months). In each case, stocks performed below average in the year before and during the recession.
The availability of easy credit reinforces a tendency to rely on debt to cover emergencies. However, hard times invariably diminish sources of credit and heighten the criteria required to borrow funds. In other words, borrowing to cover the cost of an emergency may not be an option, causing individuals to liquidate their market assets at the worst possible time.
Financial experts recommend that each household should maintain liquid investments equal to three to six months of after-tax income. For example, a couple taking home $5,000 a month should build and maintain savings of $15,000 to $30,000 before trying to save for long-term needs.
Principle 4: Minimize Taxes
Paying income tax is a legal responsibility. However, the amount due to the government can be reduced by deductions and credits to defer, reduce, or avoid income taxes. These deductions are especially beneficial for saving for health care costs, higher education, and retirement.
Health Savings Accounts
Kiplinger personal finance magazine calls health savings accounts “a powerful financial tool to cover medical expenses and save for the future.” Combining a high-deductible health insurance policy with a savings account is like a “supercharged flexible spending account that never expires,” and can serve as “an extra retirement savings fund.”
Single persons can contribute up to $3,400 in 2017 and married couples up to $6,750. The fund grows like a tax-free IRA, and distributions are tax-free for medical expenses. The account holder can invest the contributions in a variety of different investments, including mutual funds, stocks, bonds, and ETFs.
The average American couple retiring at age 65 will have expected future medical costs of $402,034, which will be only partially covered by Medicare and a supplemental policy, according to HealthView Insight. An estimated $135,445 will be paid out of pocket.
529 College Savings Plans
Millennials struggling to pay off college debts might want to protect their children from accumulating a similar obligation when it is their time to go to college. The IRS code authorizes unique saving accounts designed especially for future college costs. While contributions are not deductible from Federal tax, they may be exempt from State income taxes. The biggest benefit is the ability for contributions to grow tax-free until needed for education expenses.
Many states offer parents the ability to purchase a prepaid tuition plan, typically at an in-state, public university at today’s rates. In the past five years, tuition costs for a four-year state college have increased an average of 9% per year, according to the College Board. There are no investment options, so the benefit of such a plan is to protect against future tuition increases.
Some parents use a Roth IRA for college expenses. Contributions to a Roth IRA are not tax-deductible, but earnings on the contributions can grow tax-free unless withdrawn before age 59 1/2. The account holder can withdraw contributions at any time without a tax consequence. However, withdrawals of fund earnings before age 59 1/2 are subject to tax and a 10% penalty, unless used for education expenses.
IRAs and 401k Plans
Building an adequate retirement fund with after-tax dollars is like winning a relay race with a one-person team. While possible, success is much harder than it needs to be. Consider the case of Joe and Bob, each earning $4,000 of income every month. Both direct their employer to send $200 from each monthly paycheck to a savings account paying a 6% annual rate.
While Joe uses a standard savings account, Bob establishes an Individual Retirement Account. His contributions are deductible from taxes, and taxes on the account earnings are deferred until withdrawal. Looking into the future 30 years:
- Joe’s contributions and the earnings on his savings are taxed each year. He has to earn $266.67 each month to deposit $200 in savings ($66.67 for income taxes and $200 for the contribution). Over the 30 years, Joe will invest $96,358 of his pretax earnings to achieve a savings balance of $271,010. On the bright side, Joe will not owe taxes on the balance.
- Since Bob’s contributions are tax-deductible and the taxes on his earnings each year are deferred, he invests $72,000 of his pretax earnings and has an ending balance of $455,475 – more than double Joe’s balance. While income taxes will be due when Bob draws from his account, his tax rate in retirement will probably be less than his current rate of 25%.
Fortunately, Congress has provided such benefits to encourage everyone to save for their retirement:
- Employers can establish 401k and 403b accounts where employees can contribute pretax dollars for their retirement. In many cases, the employers match some or all of the contributions. In the latter case, the employer’s contribution effectively doubles the return on the matched portion of the employee’s contribution. Until withdrawn, neither the contributions or the earnings on the account are taxable.
- Individuals can establish their tax-sheltered retirement accounts. The most common Individual Retirement Accounts are the Traditional IRA (for those who want a deduction for contributions) and the Roth IRA (for those who want tax-free withdrawals). Individuals can establish either account or both – simultaneously or sequentially – and cover nonworking spouses with a separate Spousal IRA, although total annual contributions are limited.
Principle 5: Save Early, Regularly, and Often
From 1960 to 1975, Americans saved an average of 10% or more of their income, reaching a level of 17% in May of 1975. Since that high, the savings rate has steadily declined to a low of 1.9% in 2005. The savings rate today is 5.5%, according to figures from the Federal Reserve Bank of St. Louis. In other words, the average American saves about $5.50 for every $100 in after-tax income to pay for future expenses like financial emergencies (job loss or illness), retirement, and health care.
The Need to Save More
Unfortunately, they are not saving enough. According to a study by Fidelity Investments, less than half of Americans will be able to cover their essential living expenses when they retire. Two-thirds of retirees will depend on Social Security for a majority of their income, and one-third is likely to be solely dependent on Social Security, according to the Center on Budget and Policy Priorities.
Financial experts typically recommend a savings rate of 10% to 15%, while the Teachers Insurance and Annuity Association of America (TIAA) recommends a 20% rate of after-tax income. Realistically, this recommended savings rate should include the student debt payment.
While Millennials save less than older generations, they benefit from having time on their side. Retirement is likely 30 to 40 years in the future, so establishing a savings program today, maximizing contributions each year, and wisely investing the proceeds should allow them to enjoy their elder years without financial worry.
The Magic of Compounding
Albert Einstein reputedly said, “Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t…pays it.” Saving even small amounts regularly over an extended period can result in large sums, thanks to the return earned on the savings.
For example, saving $100 a month in a tax-sheltered IRA from age 25 to 65 and earning an average rate of 5.5% – the midrange of the six-month CD interest rate 1985-2015 – would amass a balance of almost $173,984. An investment equal to the S&P 500 (8.19%) for the past 30 years will build a balance of more than $353,000, while an investor achieving the annual growth rate of the NASDAQ index (10.94%) would have an ending balance of $761,898.
Principle 6: Play the Long Game
A variety of different assets today, including certificates of deposits, corporate and government bonds, real estate, corporate securities, commodities, collectibles, fine art, and precious metals, are available, each with unique investment characteristics of safety, return, and liquidity. While each asset has its proponents, only those with the knowledge, experience, and risk profile should invest.
When considering the returns you might expect on your investments, be realistic. Roger Bootle, an economist and columnist for The Telegraph, notes that historical returns of 10% to 15% are unlikely during a projected period of low inflation. Market experts polled by Morningstar project a much lower future annual return of the broad market of 6% to 8% in the decade 2016-2026, with bonds and savings accounts earning half that rate.
Millennials may find the temptation to trade – to “call the market’s ups and downs” – seductive. So-called experts glut the financial media with claims of fantastic returns. Their results fail to include trading costs, cover extended periods of both bull and bear markets, and are often based on assumed, not actual, trades – a method called “back testing.” For a fee, they are willing to cede their complicated strategies to eager pupils. Don’t be fooled.
A better investment strategy is becoming an “owner” of a company for an extended period. Acquiring shares in companies with good management, a growing market, and a significant competitive advantage invariably delivers growing earnings and stock prices over a long term. Your retirement funds are too important to risk by speculating on the price of a stock tomorrow, next week, or next year.
Mutual funds are an easy way to invest without the burden of analyzing individual companies or economic trends. More than half of adults invest in common stocks, mutual funds, and exchange-traded funds (ETFs), according to a 2016 Gallup poll.
Despite investment managers’ claim they regularly “beat the market,” few can consistently better the return of a broad market index like the S&P 500. According to Jeff Sommer, a financial reporter for the New York Times, no mutual fund manager has consistently delivered a higher return than the overall market.
In 2007, Warren Buffett, the country’s most visible long-term stock investor, bet $1 million that no investment adviser could pick a set of five hedge funds that would beat the performance of a low-cost S&P 500 index fund over a 10-year period. Ted Seides, comanager of Protégé Partners, took the bet. At the end of 2017, Buffett will collect the winnings for his charity, Girls Inc. of Omaha.
Buffett’s advice to investors who don’t have the time or interest to research individual companies and build a diversified portfolio is simple. In his 2013 annual letter to Berkshire Hathaway shareholders, he advised, “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund…I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”
Millennials would do well to follow his advice.
The challenges facing Millennials are unlike those experienced by older generations. Technology is changing the workplace, obsolescing thousands of traditional jobs as simple tasks become automated. Many workers will benefit from flexible work schedules, fewer hours of work, and the ability to acquire a wider variety of products and services on-demand at less cost and better quality.
Others are likely to experience mass layoffs, unemployment, and the necessity of retraining and relocation. Governments will struggle to ensure that the benefits of increased productivity are shared equitably among their constituents – the employed and the unemployed – or face growing social unrest.
In the coming decades of global economic uncertainty, preparing for the future is critical. Implementing the principles for financial security early in one’s working career and having the discipline to stay the course will enable Millennials to achieve financial independence and avoid the harsher effects of an expanding Information Age.
Are you fearful of the future and your ability to be financially secure? Have you started a savings plan? What is your advice to others?