As a generation, millennials are doing a better job of saving than previous generations. A recent Fidelity study indicated that 71 percent of millennial workers are saving for retirement, and the median age that they started was 24, six years younger than the median age that Generation X’s workers began saving. In fact, 39 percent of millennials are saving more than 10 percent of their salary.
So, are we to assume that millennials are on track for an easy retirement? The answer is complex, because while millennials are saving, they are not getting the returns on their investments that previous generations have. Forty-two percent of millennials are invested conservatively, compared with just 38 percent of Generation X investors and 23 percent of the Baby Boom generation. Millennials hold a larger percentage of their investments in cash than previous generations, and 65 percent of those age 18-39 say that investing in the stock market is scary or intimidating.
The reasons for this are somewhat understandable. Millennials came of age during the 2008-09 financial crisis, when extreme market declines left an indelible impression that preservation of capital was paramount. However, a risk-free portfolio is unlikely to grow fast enough to outpace inflation. As a result, the purchasing power of a risk-free asset declines each day.
In many cases, a better way would be to diversify the assets across several different sectors, allowing diversification to help mitigate some of the volatility of the markets while enabling the investor to participate in the general up-trend. The key for millennials, like everyone else, is to have a plan for getting from where they are to where they want to be and remaining disciplined to that plan. Fear of the markets can make staying disciplined difficult, which is one reason that people who work with a financial advisor tend to do better than those who don’t.
Millennials often are reluctant to work with a financial advisor. To capitalize on this, many brokerage firms and financial institutions have set up “robo-advisors,” which can help identify an appropriate portfolio allocation given an individual’s age and risk tolerance without having to engage a human advisor. The robo-advisor seems ideal for a generation that is comfortable with technology, and it provides the added benefit of charging lower fees.
However, is a robo-advisor truly a better solution for millennials? While robo-advisors can provide a portfolio allocation, they cannot advise and provide reassurance during volatile periods — reassurance that can make the difference between staying disciplined or getting scared and deviating from one’s plan. Such discipline is vitally important to the success of a plan, as the independent research firm Dalbar demonstrates every year.
In Dalbar’s 2017 study, the stock market (as represented by the S&P 500) returned over 10 percent per year on average for the 30 years following 1986. During that same period, the average equity investor saw only about a 4 percent return. Getting scared and trying to time the market leaves investors unable to know when to get back in. As a result, they miss out significantly on their total return.
Another significant advantage that human advisors have over robo-advisors is with respect to avoiding financial mistakes. A study by the Consumer Federation of America recently showed that 67 percent of middle-income households have made at least one really bad financial decision, where the average mistake cost families $23,000. To save a bit on fees, those who use a robo-advisor are leaving themselves open to losing significantly more to mistakes. Those dollars saved through avoided mistakes don’t necessarily show up on an investment statement, but they are quite real.
For example, articles abound with the advice that if you pay off your mortgage early, you could save $150,000 in interest over the life of the loan. While that is true, what the articles don’t say is that in doing so, you’ll give up potentially $300,000 in additional gains on the money that was instead used to pay off the mortgage.
Alternatively, someone moving in late December from Washington to Oregon might decide to hold off selling the house to benefit from putting off the tax liability for another year. However, if the home seller does that, he or she would put off the sale until he or she were an Oregon resident and thus inadvertently subject the sale to Oregon state taxes as well as federal taxes.
When choosing an advisor, it is important to work with an independent Registered Investment Advisor who is always held to the fiduciary standard, meaning that the advisor will always put the interests of the client ahead of interests of the advisor. Brokers are not held to such a standard. Adding sound advice to the good savings habits that millennials are already demonstrating could be a powerful combination.
Len Skiena is a certified financial planner and CEO of S. R. Schill & Associates on Mercer Island, a family-run business that provides wealth management services. Skiena also has been the featured financial planner in The Seattle Times.