As the Baby Boomers continue their march across the retirement threshold, all eyes are turning to the millennials to see how they will handle their money. Having come of age during one the more turbulent times in our history – a period that saw the dot com bust, the financial crisis, a string of Wall Street scandals and the decimation of their parent’s 401(k) plans –millennials have some very different attitudes about money. Some studies paint them anti-investment due in part to their lack of trust in Wall Street; while others portray them as anti-credit due to watching their parents’ struggles with debt. However, with the oldest millennial barely 30 years old, the generation still has a lifetime to shape its financial destiny. Regardless of their attitude about money, millennials can jump way out in front of prior generations simply by learning from their mistakes.
Mistake #1: Not Saving Early and Often
One of the biggest regrets shared by older generations is their failure to start saving sooner. According to one survey, 40% of recent retirees said they regretted putting off savings until they were older. Nearly two-thirds said getting an early start on savings would be the most important advice they could give a young person. What many young people fail to understand is that time is their most valuable asset; and, it is a wasting asset. The more of it you have, the greater your potential for accumulating wealth. The less of it you have, the more it will cost you to achieve your financial goals.
Consider the example of two young adults age 25. Karen starts contributing 10% of her $30,000 salary to a 401(k) plan. Assuming salary increases of 2% a year and a 6% average annual return on her money, she would accumulate more than $620,000 by age 65. Bryan, who earns the same amount as Karen, chooses to postpone saving for five years. Assuming the same salary increases and rate of return, he would have less than $480,000 at age 65. Waiting until age 35 to start saving, as many people do, would knock another $250,000 off the total. Bryan can catch up to Karen, but it would require much larger monthly contributions. Millennials have the best opportunity to avoid the high cost of waiting.
Mistake #2: Getting Trapped in a Vicious Debt Cycle
Many millennials are already familiar with the heavy burden of debt. Those who left college with student loans are already carrying an average of $37,000 in debt and many have trouble making ends meet after making their monthly payment. Another survey found that it is not uncommon for student borrowers to turn to credit cards to cover basic living expenses. Unless they are able to develop another source of income or find a way to drastically cut expenses, they are likely to get sucked into a debt vortex they can’t escape. Student borrowers should first look for relief with student loan repayment options or student loan refinancing to lower their monthly payments. Even if your income can support it, taking on new debt just to maintain a lifestyle never makes sense. Millennials need to learn early on the difference between good debt – used to finance a house or finance an education – and bad debt – used to pay for things they can’t afford, and avoid the latter at all costs. Too much bad debt can squeeze out the availability of good debt when it’s needed. The biggest piece of advice you are likely to receive from anyone who carried debt through the Great Recession is to avoid unnecessary debt.
Mistake #3: Investing too Conservatively
Having watched their parents struggle through two stock market crashes, millennials have developed an aversion towards investing in equities. While that may be understandable, it could prevent them from achieving the financial independence that is eluding many in their parents’ generation. For young adults who start investing early, there is no need to take unnecessary risk because they have time working for them. But, they still need to generate sufficient returns to outpace inflation while accumulating enough capital to last up to 35 years in retirement. Millennials should have faith in the stock market, which has risen 200-fold since World War II – having endured several wars, multiple recessions, political scandals, several stock market crashes, a global financial crisis and terrorist attacks.
The first thing to understand is that bear markets and stock market crashes happen with some regularity. Second, every bear market or market crash has been followed by a bull market or market recovery that has gone on to surpass the previous market high. It’s called the market cycle, which has resulted in 23 bear markets and 24 bull markets in the last 100 years. With an investment horizon of 30 to 40 years, most millennials will experience as many as 10 complete market cycles, more than enough to overcome the damage caused by any one down market. Millennials have the best opportunity to benefit from a well-diversified portfolio of stocks and bonds that can generate positive long-term returns.