5 Questions Millennials Should Ask Themselves When Investing
Millennials recently overtook Baby Boomers as the largest generation in the U.S., but when it comes to investing, Millennials have a much wider gap to cross. According to
a survey by Student Loan Hero, Millennials’ financial priorities are quite different from previous generations thanks to student loans, minimal income inflation, rising home prices, and preferences for renting over ownership. Financial goals and challenges have certainly changed, but the desire to succeed and to minimize financial strain and worry cross generations. As the “me generation” gives way to the “we generation,” this new group of up and comers are facing a different set of challenges.
If you’re a Millennial who wants to start investing money for your family’s future, here are five crucial considerations to make before jumping into the markets:
What is this money to be used for? Do you have a specific goal in mind? Is this for retirement or a more immediate goal? A new home, a child’s college education? How would not reaching the intended goal affect your family?
Asking why is a cornerstone to the investment decision.
Your reasons for investing will outline the goal setting process for you. A great deal of the where and when of what is done with your money in the investment arena depends on the reason you are there in the first place.
What Should I Invest In?
Investing is quite simply a game of information. Millions are spent to gain the smallest of advantages in this vital commodity. How does a new investor combat this? Are you at a disadvantage? You can, and you are. Quite simply:
You need a strategy.
First the easy part.
Investors should focus on the term they have to reach a goal and take the first step by building a diverse portfolio that maximizes the probability of success. Diversification is one of the fundamental lessons of investing, but what does that mean? Does it mean you should spread your money across many funds or sectors? Maybe, Not necessarily. Go back to the why of your investment. An investor must align their goals, time horizon, and risk with the importance of accomplishing the goal. This is a personal decision that requires knowledge of all of your options.
While risk can never be completely removed, diversification can address some of the risk and volatility of price fluctuations of specific assets. Seek low-cost diversified investment alternatives. I often work on building core holdings with clients with fund costs of less than .20% while gaining exposure to over 2500 securities.
As a group, Millennials have been notably good about saving for retirement, but nearly 80% of Millennials haven’t invested in the stock market outside of their 401k. Many blame a lack of capital as the main hurdle, but in time this will become less of a problem and as millennial capital grows, the more likely issue will not be the lack of capital but overconfidence. Schroders 2016 Global Investment study found that over 61% of millennial investors thought they were above average investors compared to 45% for those over 35. Behavioral bias may be the lurking challenge.
Do I need a Financial Professional?
A major deterrent that Millennials cite when asked why they’re not investing is the cost of hiring a professional to optimize their investment portfolio. However, several affordable alternatives exist, from DIY investing platforms like E*TRADE to professional fiduciary Registered Investment Advisor (RIA) firms such as FamilyVest.
When making the decision of whether or not to go at it on your own, you have to take some time to introspect and weigh the pros and cons. Let’s look at a few reasons why people can get turned off and frustrated while handling their own investments:
- Loss – Nothing deters more than losing some money.
- Time – A long term process implemented with a short term focus. We can be an impatient bunch, can’t we?
- Cognitive and Behavioral biases – The impact of cognitive bias that we do not realize until after the error (sometimes a big one!) is made.
- Not fully understanding the playing field. Many people don’t have the time, money, or frankly the interest in learning all about the markets and how they work. It can be a real snore for folks. With that said, human nature dictates that we also don’t want to miss out on making money, right? So, it’s not uncommon for people to jump in the markets without having all of the information they need to make the best decisions for themselves. This often leads to errors and losses and a disenchanted investor.
The goal of a quality financial planner is to help clients understand their why and then to teach them a process with the tools and structure needed to create the investment program that will achieve the outcome that they wish in a manner that fits their individual needs. Understanding along the way what bumps may occur and develop and discussing these possibilities before they occur allows you to be prepared for whatever the world throws your way. This is where independence and objectivity are key. It’s tough being objective about your own money. A trained independent and objective advisor can add value and help increase the probability of you hitting your goal. Vanguard describes this as advisor alpha and estimates that advisors can help investors improve there performance by as much as three percent.
How should I Invest While Paying Off Debts?
If you’re still paying off student loans and/or credit card debt, deciding the best allocation of your money is not all that complicated if you take a look at what you are given. Ah yes, a penny saved is a penny earned. For instance, student loan interest rates currently range from 3.76% to 6.31% and the national average for credit card interest is 15%. If you have any of these debts, think of your interest rate as a guaranteed return on your investment. You will never find another risk free investment paying 15%, so take it by paying off these debts first. Of course, there are other strategies for paying off debt, but the trade off remains.
Not only are you earning the 15% on every dollar of that debt that you wipe out, but you are also freeing up the cash flow that is required to keep that account current. When that minimum payment is gone, then that will be just that much more that you have to put towards your other goals. Of course, there are circumstances when this is not the best option. Let’s say your employer has a 401k plan and they match you dollar for dollar on the first 5% of savings. Well, you just beat that 15% return on paying down your credit card debt. Your employer just paid you a 100% return on 401k contribution. Yes, a 100% risk-free return is pretty sweet and should always be utilized if available.
Investing in a Roth IRA for retirement is another important consideration when you’re in the midst of paying off debts. If you focus solely on debts and promise yourself that you’ll invest the maximum contribution ($5,500 per year) once you’re debt-free, you could be missing out on years of valuable interest accruals. For example, given an average rate of return of 6%, someone who makes the maximum contribution each year starting at age 30 can expect to have around $650,000 saved for retirement by age 65 (after investing just $192,500 over 35 years!).
It does become a bit more complicated when it comes to student loans. If you have a rate at 3.76% and you are in the 25% marginal tax bracket, your investments would only have to earn a little over 2.82% tax adjusted to validate holding on to the loan. The other wrinkle to add is the $2500 cap on the interest deduction. This will often come down to your situation and preferences. When I had this decision to make for myself, I chose to fund my retirement accounts to the match and then also to the maximum allowable for that year. At this point, all remaining cash flows were directed to pay down the student loans before I made any non-retirement investments. Why?
- I expected my long term return on retirement account savings > 2.82%
- My short-term taxable account return on savings is unknown, so I went with the sure thing.
Many may choose a different path. You could make the argument that the 2.82% is a rather low hurdle and decide that it is the cheapest loan you could ever take and decide to keep it and invest extra cash in a long-term taxable account. This requires a higher tolerance for risk. Many of these decisions are best modeled so that you can see the impact of the decisions over time and circumstances. Scenario analysis adds, even more, clarity as you can see how small and substantial changes in relevant variables impact your path and ability to reach goals.
I often find with clients that when they see the various outcomes, they come to the realization that their goals are often achievable with a lower risk strategy. Creating a strategy that gets you to your goals while minimizing your downside is the key to successful planning.
Can I Maintain Focus on the Long Game?
The markets can be pretty volatile, and nearly anything can cause the value of stocks and bonds to rise or fall: political uprisings in resource-rich or trading partner countries, the Fed changing interest rates, new employment figures released, elections, natural disasters, and so on.
This means that there will be good times and bad times for your portfolio if you are a Millennial, but a momentary dip in an investment’s value should not spook you enough to sell it off right away. Market crashes are not uncommon in the U.S. and global economy, and the smartest investors tend to hold onto their assets during rocky moments because a rebound usually follows after a crash. Focus on your long-term goals (retirement, saving for a home, your child’s education fund, etc.) and let your investments grow over time instead of withdrawing whenever some bad economic news appears.
My goal is to help clients understand the significance of changes in market sentiment and fundamentals while helping them focus on the long-term goals and expectations as developed in their investment policy statement (IPS). At FamilyVest, every client gets a personalized IPS. We define the process, goals, and risks and we discuss issues before they arise. It’s always good to have a touchstone to the “previous you” that created your goals and parameters. There will be turmoil; there always is. There will be naysayers; there always are. A trusted advisor is one who has the depth of knowledge and experience to help keep you aligned with the more rational you.
To learn more about FamilyVest and how we can help you with your investment strategy, schedule a consultation today!