Gen Y is in Trouble

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Generation Y is loosely defined as anyone born between the years 1980 and 1999. This means Gen Y's age range is from 13 to 32. The reason I want to clarify this right away is, there are frightening statistics from MFS Investment management about this age group when it comes to investing. According to this survey, 40% of Gen Y investors (ages 18 – 30) said they agreed they “will never feel comfortable investing in the stock market”. Another 30% said that protecting principle was their primary investment objective. However, the most unbelievable statistic is that Gen Y has allocated 30% on average to cash, and just 33% to stock funds.

Why does all of this matter? To be blunt, because this age group has the most to lose by not being aggressive enough. I'm not even talking about this group putting everything into stocks and risking it all. What I am talking about is, Gen Y on average has at least 30 years until a traditional retirement age of 62. In this 30 year time frame, if Gen Y wants to save and protect principal they are going to need to save a lot. With 30% of Gen Y suggesting that principal protection is their primary objective they are resigned to cash investments and possibly short-term bonds. Where cash is concerned, the average Gen Y person can expect to hopefully keep up with inflation. However, their real return is zero. That is fine if you are able to save a large chunk of your money. However, this is not something that American's are very good at doing. In the last 50 years, a U.S. News article reports that the highest savings rate was 11% back in 1973. In the last 30 years this rate has only been at 7 – 8% a few times. Most of this time, the savings rate vacillated between 1% and 5%. Let me give you an example of how difficult it would be for a Gen Y person to save their way into retirement with a real return of zero.

Let's say our Gen Y person is college educated and gets a good paying job at $70,000 a year (no small feat in this economy). If this same person gets a regular 3% cost of living increase in their salary, by year 30 when they retire, they will be making about $165,000 a year. Because taxes are inevitable they will routinely lose somewhere between 25-30% or more to taxes. Now for the daunting task. Let's assume that this Gen Y person saves the historical record high of 11% of their income. In year one they save $5,775. They continue to save 11% every single year until age 62. By the end of the 30 years with a zero real return guess how much they have? $262,444 is the grand total. Now the problem? This same Gen Y person has an average life expectancy of 78 in the U.S. They retire at 62, and now they need to make their funds last for at least 16 years. The most this person can withdraw is 25% per year. They will start with about $65,000 but by year 16 they only have about $3,000 to their name. Not to be morbid, but this person better die at or before 78 as well or they run out of money completely. Clearly this isn't a workable solution.

So protecting principal only won't work, according to the MFS survey about 30% of Gen Y needs to read the prior paragraph and realize the problem with their strategy. What about short-term bonds? This same scenario as above with short-term bonds equals $472,821 in total assets in 30 years (assumes the 10-year historical return of short-term bonds of 4.02%). That's much better, but if this person wants even $50,000 a year to live off of, all of their funds are gone in year 12. Again they can't make it even 16 years in retirement on this sum of money.

What if the investor chose a fund like the Vanguard Inflation-Protected Securities Fund? Using the same scenario, gives the investor $801,502. This is more like it. Even with a historical return of 7.17% like this fund has returned, they will be fine at $50,000 or even $70,000 a year withdrawals. However, keep in mind this would be effectively half of what they retired at. Also keep in mind that this doesn't account for draw down activities like, buying a home, buying cars, weddings, and other large expenses that come up in life. If this same Gen Y person needs $100,000 in retirement (60%) of their pre-retirement income they run out of funds by year 12.

So what is the average Gen Y person to do? If only protecting principal won't work, and short-term bonds don't do the trick, what else might work? First, contribute to any 401k, 403b, or other retirement plan that your employer offers. If there is a company match, contribute at least enough to get the entire match. Employer matching isn't as prevalent as it used to be, but it still does happen. This takes your money and invests it first before you pay taxes, and it shields your investment gains from taxes until you start to use the funds. Second, look at stocks. I know that over the last 10 years stocks have lost the race to many bond funds, but that is not the case with all individual stocks. Also what do you think happens when one asset class outperforms over a certain period? Usually that asset class (bonds in this case) will underperform while other assets (like stocks) catch up.

I can give you two excellent examples of stocks that every Gen Y individual probably has some experience with. Do you have a cell phone? Do you use Verizon (NYSE: VZ)? In the last 30 years, Verizon stock has climbed from about $8 to $40 a share. Over the last 30 years, that works out to an average increase of 5.7% per year. That doesn't even count the multiple thousands of dollars in dividends you could have collected over that time. Another huge difference between Verizon stock versus bonds or cash is, Verizon's effective yield has risen over time. If you bought 30 years ago, your effective dividend yield is 24.54%. Want another suggestion? How about McDonald's (NYSE: MCD)? On its march from $2.43 a share 30 years ago, to over $92 today, a long-term investor's average annual return has been 13.30% In the same way, McDonald's shares have an effective yield of 115%. Think about that, if you bought McDonald's shares 30 years ago, you would be collecting more in dividends each year than you originally paid for the shares. The point is these were well established companies 30 years ago, and they are equally interesting opportunities now. You don't have to find the “next” something to do very well in the market. Sometimes investing in the original is more than enough.

Long story short, Gen Y wake up! If things stay as they are 30% of Gen Y risks not having nearly enough funds in retirement. Another 40% are in serious trouble because they say they won't ever invest in the market. You have time on your side, if you were 50 or 60 my advice might be different, but you can't touch retirement money without a serious penalty for 30 or more years! Your future and your family's future net worth depends on the decisions you make today.


MHenage owns shares of Verizon Communications. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.

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