“It’s virtually impossible for young workers to deploy their investment capital too aggressively, because their human capital overwhelms it.” – William Bernstein
Millennials have been taking it on the chin lately for their lack of basic financial knowledge and understanding.
There was a fascinating piece in The Week by Ryan Cooper called The Confessions of a Millennial Who hasn’t Invested a Dime in the Stock Market that does a wonderful job of breaking down the problems many young people have with saving and investing from his perspective.
Cooper captures all of the broad issues that young people face when making money decisions. I’m going to use some of the issues he lays out and give my take on the possible solutions.
The Problem: Changing Behavior is Hard
“Much of that can surely be chalked up to laziness and incompetence on my part. But I think it also has to do with how Wall Street malfeasance, vast inequality, and the complexity of the financial system combine to create an enormous psychological barrier when it comes to investing, keeping all but the rich out of owning stocks and other assets.”
The Solution: Automated Systems
It’s much easier to place blame on others than to actually change our own behavior because complaining doesn’t take any effort, but changing behavior is hard. The jury is still out on whether or not financial literacy programs work, but what is known is that knowledge alone isn’t enough to change bad behavior. You must find a way break bad habits. Unfortunately, just trying harder doesn’t work because we become paralyzed by an overwhelming number of choices and decisions.
The easiest way to change your behavior is to develop automated systems that require only a few big decisions up front. Technology-savvy Millennials should have no problem setting up this aspect of their finances. You can now automate nearly your entire financial eco-system (bill payments, retirement & savings account contributions, rebalancing your portfolio, etc.). This basically takes yourself out of the equation the majority of the time to cut down on unforced financial errors. Make changes in the future if you’d like once you know what you’re doing, but automating right away is the best way to build effective habits in a systematic way.
The Problem: Complexity
“I’ve read and written a great deal about economics and finance, but I can tell you that the actual mechanisms of asset purchasing are intimidating as hell. Just looking at a 401(k) booklet feels like the hotly acidic fingers of Satan clutching at my trachea. It’s almost as if I’d rather die in poverty than figure out which investment option would shaft me the least, between Great-West Lifetime 2045 Fund II T1, Columbia Small Cap Value Fund I Class A, Nuveen Equity Index R3, or Oppenheimer Rising Dividends N.”
The Solution: Simplicity
You could do much worse than making your only rule of thumb for your finances to keep it simple. My ideal retirement plan would be for the government to open up the TSP for all employees. Because that makes way too much sense, it will probably never happen.
But there are still simple options out there for investors that are afraid of the typical Wall Street huckster. In your workplace retirement plan, you can choose a targetdate fund until you become comfortable building your own portfolio (this also reduces the behavior performance gap).
Vanguard is a private company that doesn’t serve public shareholder interests and passes along the savings to their investors. Charles Schwab offers fairly straightforward investment options at a very low cost, as well. Also, from what I can tell, the robo-advisors such as Wealthfront, Betterment and Wise Banyan are all looking to help those just starting out by offering their portfolio services at a minimal cost.
The Problem: Trust in the System
“And it’s not just the complexity. The whole ordeal just feels like a giant grift that taints your soul just thinking about it. I hear ‘we’ll help you design the investment portfolio that fits your risk profile,’ and I translate ‘bankster scum are coming for your wallet.’”
The Solution: Read More
Read some personal finance books (see this list from William Bernstein as a start). Then read about the history of the financial markets (my list here). The only way to become comfortable in a foreign area of expertise is through experience or a broader understanding of history. Since the experience part comes later a good place to start is by developing a thirst for knowledge.
The Problem: I’ll Wait Until I’m Ready
“I know, intellectually speaking, that I should find a boring old index fund and sock my money away there. It probably wouldn’t even be that hard! But emotionally, it feels like soaking it in kerosene and storing it at a fireworks show. Very easy to just put it off and do it some other time — maybe after the next time the market crashes.”
The Solution: Start as Soon as Possible
You’ll never be “ready” to get your financial house in order. Out of school, many have student loans. The next step is usually marriage or maybe buying a house. Then kids come into the mix down the line. There’s never a perfect time to start saving and you’ll always be dealing with imperfect information about the future. There will always be an excuse to put it off until later (including the possibility of a market crash).
The best way to save and invest is to start now and build up your tolerance incrementally. If you start saving small amounts you realize after a couple of months that you don’t really miss that money — assuming you’ve automated your savings and never get a chance to spend it. Then you slowly increase that amount over time until you are saving much more and the small amounts eventually build on themselves.
In the absence of founding a tech start-up, the best option for 99.9% of young people is to slowly build saving and investment portfolios over time. It’s a decades-long process but it’s the prudent choice and the one that actually reduces your risk in the stock market.
The biggest risk for young people isn’t that Wall Street will take advantage of them or a big bank will suck them dry with fees. Risk comes from not saving money now to allow for the enormous benefits of compound interest to take effect over time.
Those that aren’t investing in the financial markets are assuming volatility is their biggest risk so they stay away. The biggest financial risk for my fellow Millennials is not stock market volatility. A globally diversified stock portfolio is actually the least risky option for young investors.
The biggest risk is not taking any risks at all while they’re young.
Millennials and the New Death of Equities