Executive Summary
With stocks experiencing a lost decade, bonds barely keeping up with inflation, and savings accounts generating virtually no yield at all, it is a daunting environment for clients to save and accumulate. Many question whether saving is even worthwhile; if the client can't earn anything on money saved, there's little economic benefit to delaying gratification, and the incentive is to just spend it now. On the other hand, low returns also mean that if the client ever hopes to retire, it may require more saving than ever, given that low returns mean less compounding. And so the real question for Generation Y - today's young adults - is which way will it go: will low returns disincentivize saving, or help people redouble their efforts to save even more?
The inspiration for today's blog post comes from a recent TD Ameritrade survey released a few weeks ago, indicating that Generation Y (today's teens and twenty-somethings) are saving more rigorously for their retirement than their parents and grandparents. According to the survey, 25% of Generation Y (and 23% of Generation X, their older brethren in their 30s and 40s) are saving in their 401(k) plans, while only 16% of Baby Boomers are doing so (despite the fact that Boomers are much closer to retirement, too!).
In some regards, this is a surprising trend. One of the most fundamental principles in financial planning is the concept of the time value of money - that a dollar received in the future is not worth as much as a dollar received today. In investing, the reverse concept is also true: investors are only willing to give up a dollar today if they receive some return (interest, growth, etc.) on their investment when the dollar comes back in the future. Otherwise, there's just no economic benefit to delaying gratification.
Yet for some reason, today's young people are seeing the benefit of delayed gratification, even if their money won't be worth much more in the future (and after inflation, it might even be worth less!). And indeed, it really may not be worth much more down the road, given that Generation Y also seems to be highly averse to stocks, given the difficulties of the past decade, with a whopping 40% suggesting they will "never" invest in stocks in their lifetime, and the typical Gen Y holding 30% of their portfolio in cash!
Nonetheless, Generation Y is saving. And their higher savings levels also implicitly mean that they are spending less, which suggests that not only might they manage to save more than the Baby Boomers for retirement, but they also will need less retirement funds to maintain their lifestyle, as the lifestyle is already more modest due to the ongoing savings in the first place!
Notably, this behavior also suggests that when we lament the low savings rates of Baby Boomers, it may actually have much to do with the fact that they had such high expectations of returns; they really did think they could get away with relatively modest savings, and just hoping that the compounding would work for them. Unfortunately, though, this has clearly not been the case, as the final decade that was supposed to get them to the retirement finish line has instead been a catastrophe of non-compounding. Clearly, at least in retrospect, the baby boomers relied too much on their money doubling in the final decade before retirement, and not enough on savings. One has to wonder if the baby boomers might have been far more prudent savers if the first half of their accumulation years were not filled with a raging bull market that averaged returns in the high teens for almost two decades, ratcheting expectations to unsustainable levels.
In any event, we do appear to be witnessing a remarkable transition: a Generation Y that is actually acknowledging that low returns mean you have to save more in order to achieve goals, and similarly who are not daunted by low returns in their efforts to save and reach their goals. In some ways, it appears that this youngest generation is now beginning to mimic not their grandparents (the Boomers) but their great grandparents, whose formative years were shaped by the Crash of 1929 and the Great Depression and who consequently eschewed the use of debt and stock investing... yet still managed to live modestly, save prudently, and enjoy a not lavish but at least comfortable retirement.
On the other hand, ironically this young generation could present new challenges to the financial planning community, which appears to have a strong self-selection bias towards risk-takers. Will the planning profession be able to adapt and communicate to a more saver-centric, less-stock-oriented client, or has financial planning gone too far in making itself appealing only to risk-takers with its attitude that only by taking stock risks can you achieve retirement success (despite the fact that that formula has turned out to be disastrous for so many Baby Boomers and was unnecessary for their parents)?
In the meantime, though, it's great to see today's youngest generation choosing to view our low return environment as a reason to save more to make up for low returns, rather than save less and give up on delaying gratification. We'll see if the trend can hold.
So what do you think? Are you surprised that Generation Y is saving more, even while earning less and investing more conservatively? Were the Baby Boomers too addicted to high stock returns, or is Generation Y swinging the pendulum too far in the other direction? Will financial planners have trouble relating to a Generation where 40% claim they'll be unwilling, ever, to invest in stocks? Or can the planning profession adapt?
