Are Millennials Doomed in a Lower Return Environment?

Plenty of people in the finance world were talking about the study put out last week by the giant consulting firm McKinsey on the prospects for lower market returns over the next 30 years than we’ve experienced over the past 30. Here are the numbers from the report:

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And here’s the takeaway from Bloomberg:

Turning 30 just got a lot scarier.

A coming collapse in investment returns means that people that age today will have to work seven years longer or save almost twice as much to end up with the same nest egg as those of roughly a generation ago.

So says the research arm of McKinsey & Co. in a new report that argues that investors of all ages need to resign themselves to diminished gains.

The consulting company maintains that the last 30 years have been a “golden era” of exceptional inflation-adjusted returns thanks to a confluence of factors that won’t be repeated. They include falling inflation and interest rates, swelling corporate profits and an expanding price-earnings ratio in the stock market.

The next two decades won’t be nearly as lucrative, even on the optimistic assumption that the world economy snaps out of its recent funk and resumes growing at a faster clip, according to the McKinsey Global Institute report titled “Diminishing Returns: Why Investors May Need to Lower Their Expectations.”

First of all, plotting out economic or market assumptions over 30 years is kind of silly because it’s basically impossible. (My colleague Barry Ritholtz covers some of the the problems with this type of forecasting here.) The stock market is nearly impossible to predict, as is economic growth or inflation, but bonds are more or less governed by the laws of math over the long-term. So at first glance, sure, these numbers could be reasonable. Regardless, let’s assume for the sake of argument that their forecast is correct.

Do lower returns over the next 30 years automatically spell doom for Millennials who are investing their money?

Not necessarily.

The biggest problem with this line of thinking is that is fails to consider the sequence of these returns. Even if stocks do rise 6.5% per year for the next three decades, the path they take to get there will matter much more than the annual average return.

Let’s look at two examples to see why this is the case.

Scenario #1: A young person starts saving $5,500/year and increases that amount by 4% each year to account for inflation and salary increases. They save for 30 years and earn a steady 6.5% each and every year. After 30 years they would end up with roughly $743,000.

Scenario #2: A young person starts saving the same $5,500/year and increases that amount by 4% each year to account for inflation and raises. They save for 30 years as well, but instead of earning a steady 6.5%/year they earn just 3.2%/year, with alternating annual returns of +12% and -5%, for the first 20 years. Then they earn 13.5%/year in the final 10 years. This still works out to an annual average return of 6.5% just like in the first scenario, but because these returns were so poor in the early stages of saving and higher in the latter stages, this person’s ending balance was closer to $1,000,000.

Both scenarios saw the exact same amount saved over the exact same time frame and earned the exact same annual returns. But the sequence of those returns caused a huge difference in their ending balances. The second scenario was more than 30% higher than the first one.

The thing that most young investors can’t seem to wrap their heads around is the fact that you want lower returns during your early years when you are a net saver. It allows you to buy more shares in the stock market at a lower price. A decade or even two decades of poor returns would be an amazing opportunity for Millennials. Throw in a couple of market crashes in there and that’s even better.

This example illustrates the fact that luck can have a lot to do with how much money you end up with. Some people are simply born into a perfect market cycle while others have more of an uphill battle. Whatever future market returns we end up seeing, one thing is for sure — they will not exist in a steady state like you see in a simple retirement calculator. Averages never tell the entire story.

This report did have one piece of great advice for young people — it makes sense to increase their savings rates and plan for the worst. Not only does this mindset allow compound interest to do most of the heavy lifting for you, but a higher savings rates, and thus slower lifestyle creep, is a great way to give yourself a margin of safety in case things don’t go as planned in life (and they never do).

The biggest problem is that is can be difficult for young people with little financial or market experience to have the guts to continue buying when things don’t look so good and markets are falling or going nowhere. That’s probably why one of the best financial decisions you can make early in your working life is to automate your investing contributions, increase the amount you save every year and then don’t look at your statements very often.

No one has control over the market’s performance over their lifetime, but you can control your personal savings rate and how you handle your biggest asset — human capital.

End of Golden Era for Investors Spells Trouble For Millennials (Bloomberg)

Further Reading:
Trading Costs & The New Market Averages
Financial Advice For My Fellow Millennials

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  • Jim Clark

    20 year predictions from a group who can’t so one year accurately??? But as the old saying goes: pray for the best, expect the worst and take whatever you can get.

  • Kevin Lynch

    Interesting perspective when you add in sequence.

  • MG

    I am so glad that you started out your comments with “plotting out economic or market assumptions over 30 years is kind of silly because it’s basically impossible.” I am old enough to remember when in 1979 these same firms were saying that the market was in a state of long term poor performance, and Business Week published a cover titled “The Death of Equities”. McKinsey and, it seems, most of Wall Street is STILL selling this bunk. In 1979 when the article was published the Dow was at 875, and now it is 17,876 (a 20 fold increase). That basically sums up the value of these idiotic pessimistic long term “forecasts”!

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    Who cares about market returns when I’m earning $75,000 and getting a 4% raise every year for the next 30 years! I’ll just save 100% of my earnings from my final 5 years of employment and not worry about any of this craziness. 🙂

    But seriously…as much as the last 30 was the golden era, the next 30 could very well be the rusted out old junker up on blocks in the front yard era. Higher cost of living, higher cost of borrowing, lower stock and bond returns, lower growth, less credit, et al. could create a strong headwind for a substantial amount of people.

    But, yeah, no one can see 30 years out.

  • Wez

    I’m willing to bet two things:

    1. McKinsey & Co. may not even exist 20-30 years from now


    2. There will be another firm trying to predict the future in their place, and just as wrong.

  • blackbean

    Yeah, well, whatever. They are wrong. All the big wigs, prognosticators, forecasters, economists and companies that do this kind of stuff were wrong about 2000 and 2008. But there is an even bigger reason they are wrong again.

    When I landed in the US in 1997, everywhere I went and everything I read just had positive news. There were going to be labor shortages soon and everybody was going to be work-2-hours-a-day-from-home millionaires. Everybody was going to work less and earn more. Basically, surpluses as far as the eye can see. For households, business and the government. And there was no end in sight to all this wonderful delight. Everybody was going to be paid to do nothing, there was just too much productivity growth and economic well-being going around.

    Since 2008, the forecasts has been the EXACT OPPOSITE. Doom and gloom with NO END IN SIGHT. Higher unemployment, lower market returns, deficits forever, etc. This makes me (almost) irrationally optimistic about the future.

    • I totally agree and it’s nice to see somebody that keeps up with the false news published daily. Every day there is a new blog, post and video about recessions, crashes, & gold. The entire time these articles and videos have been being published the S&P has gone up 2 fold at minimum. As long as all these doom and gloom predictions remain the market and the economy will actually do much better and keep maintaining their strength. Why, do you ask? Because, honestly, the smart money is actually lying to the sheep and getting them on the wrong side of the trade, in order to keep the public scrambling and buying in and out, pumping up the market in the meantime due to fees and money movement. The sad part is, the public is constantly being lied to, from the internet to CNN. There are only a few people telling it like it really is, and these people are in the one percentile. This is the same ratio of the people whom were forecasting the recession in 2006. Funny this is that the other 99% were talking about making millions easily in all markets when the crash hit and that is the exact opposite of what the 99% are talking about now. They are still stuck on the wrong side of the coin, with the market crash. People do not realize how fast time flies. People are still talking and predicting recession, 8 years later. All they have to do, is take a second and look at the track record of the economy since they started with the nonsense in 2008 when it was too late and they will see the market has gone almost straight upward the entire time. #manipulation

  • kp

    interesting post, but not sure i agree w the logic.

    it’s true that you’re better with low returns first, and then high returns later,
    versus average returns throughout.

    but there’s some magical thinking involved: in this telling, the low returns first somehow make it more likely that you get high returns later. Why would that be?

    precisely because you can’t predict the stock market, the best estimate we have is where we are now. which is low returns.

    so what this post is saying is that if we end up having an exceptionally high rate of return in 20 years (13.5% !), we’ll be happy. that goes without saying. but the mckinsey report’s point is precisely that that’s unlikely, whatever that prediction is worth. (and of course, even if that happened, we’d still prefer to have average returns now, rather than low returns.).

    it’s just that if we got to allocate our returns across time, we’d like to start of with low, and then move to really high. but that’s not happening.

  • Predictions are so hard to make…especially about the future.

  • LeonardCTekaat

    Common Sense

    During the the boom cycle, the 2% Appreciation/Inflation Taxation Policy, instead of higher interest rates, used by the Federal Reserve to control the boom cycle, will reduce excessive demand, created by the excessive credit use by people at the top of the economic ladder, allowing the economy to continue to maintain normal production, and consumption. Thereby maintaining employment of the middle class, and working poor. Making it possible for the middle class and the working poor to retain their homes and wealth, reducing poverty, and reducing the need for greater government deficit spending during the recession cycle.

    Ben, Please comment on this idea.