Millennials are way too conservative (well, financially speaking, at least). According to a Wall Street Journal analysis, twentysomethings’ most common money mistake is investing too conservatively, putting too much money into cash and bonds and not enough into equities. It’s understandable – between coming of age during the Great Recession, graduating into anemic job markets, and carrying record amounts of student loan debt, it’s no wonder that millennials are gun-shy about investing aggressively.
But while a low-risk portfolio produces better outcomes during a downturn, it’s a severe handicap in the long term. We’ll compare conservative and aggressive portfolios, discuss why your 20’s is the time to be bold (especially when it comes to your retirement accounts), and explain how to avoid common psychological pitfalls.
Back to basics: Comparing investment styles
First off, what does a “conservative” investing strategy look like, and what differentiates it from an “aggressive” one? An investment portfolio usually consists of a variety of financial vehicles, including money market funds, Certificates of Deposit (CDs), bonds, and stocks.
Money market funds and CDs are super-safe investments. CDs usually guarantee a yield (averaging 0.52% for one-year CDs in October 2019); money market returns hover in the low single digits but almost never lose money. Bonds are one step closer to risk: While they perform better than stocks during bear markets, they have much lower returns during boom years (think 5-6% for long-term government bonds). Finally, stocks are the most aggressive investment. Since 1990, the S&P 500 (considered a good indicator of U.S. stocks overall) varied wildly, from gaining 34% in 1995 to losing 38% in 2008.
A conservative investment portfolio is weighted towards bonds and money market funds, offering low returns but also very little risk. This is the kind of portfolio you’d want if you’re more scared of losing money than not making money – for example, if you’re retired and these funds are your sole source of income. Aggressive portfolios are heavily weighted towards stocks and are better for those who can handle a few bear markets in exchange for overall higher returns.
There’s variation within these two groups – for example, a swing-for-the-fences aggressive portfolio may feature high-growth, small-cap stocks, while a less risky aggressive portfolio may focus more on blue-chip stocks. And finally, a balanced portfolio is – you guessed it – a balance between conservative and aggressive mindsets.
So what do conservative, balanced, and aggressive returns look like? Vanguard took a look at the annual returns of all three groups from 1926 through 2018. Here’s a summary of their findings:
|Portfolio type||Avg. return||Best return||Worst return||Years with loss (out of 93)|
|Most conservative (all bonds)||5.3%||32.6%||-8.1%||14|
|Balanced (half bonds, half stocks)||8.2%||32.3%||-22.5%||18|
|Most aggressive (all stocks)||10.1%||54.2%||-43.1%||26|
Basically, an aggressive portfolio gets you much better returns on average. On the other hand, you’re more likely to lose money and more likely to lose big.
Invest aggressively while you can
A conservative portfolio can seem enticing, especially if your first experience with finance was the 2007 stock market crash. After all, humans are programmed to hate losing more than we like winning. But when you’re in your 20’s, you have a long time until retirement and can afford to ride out downturns. In fact, here’s one allocation rule of thumb: Subtract your age from 100, and invest that percent of your portfolio in equities. For example, if you’re 25, 75% of your money should be in stock. There are two main reasons that young people should be bold investors.
Reason 1: You won’t need the money anytime soon
If you’re already retired and your 401(k)’s value plummets, you’re in a really tight spot (this is what happened during the Great Recession). But if retirement is decades away, an individual year’s gain or loss doesn’t matter. While stocks may bounce around more than cash or bonds, on average, they deliver much better results – and at this stage of your life, you care about maximizing the average return.
Reason 2: Small differences grow over time
You often hear the miracle of compound interest cited as a reason to contribute to your retirement funds as early as possible (and you should!). It also highlights the importance of maximizing the returns on those contributions – a conservative portfolio’s slight lag in performance becomes a massive gap as years go by.
Let’s say you’re 25 and plan to retire at 65. You want to contribute $5,000 annually towards your 401(k). Using a calculator, how would your contributions perform according to Vanguard’s historical averages?
|Portfolio type||Avg. return||Money at age 65|
|Most conservative (all bonds)||5.3%||$650,099|
|Balanced (half bonds, half stocks)||8.2%||$1,365,441|
|Most aggressive (all stocks)||10.1%||$2,273,988|
Based on the averages, investing aggressively gives you over three times as much money to retire with compared to investing conservatively. Now, this doesn’t account for reallocation – as you get older and your retirement nears, you’ll want to shift your portfolio to more conservative investments to minimize risk – and averages aren’t guaranteed returns. But the difference is still striking, and a pretty compelling reason to focus heavily on equities so that your money grows as much as possible.
How can you get comfortable with aggressive investing?
Like we mentioned at the top, millennials have every right to be wary – the Great Recession’s impact still echoes through most of our bank accounts. According to the Wall Street Journal article, many people in their 20’s aren’t comfortable with their finances and go with conservative portfolios as the safe, default option. The article noted that, between the financial crisis and 9/11, twentysomethings are abnormally risk-averse. So how should you balance a fear of risk with a need for good returns?
Some consider replicating target-date funds
Target-date funds are mutual funds tailored to a certain retirement date – target-date 2060 funds are for people who aim to retire in 2060, target-date 2030 funds are for those who retire in 2030, and so on. A target-date 2050 fund, for example, would be aimed at twentysomethings and heavily weighted toward equities. A target-date 2020 fund would be geared toward older investors, and have a much more conservative allocation. A target-date fund for your projected retirement year is a shortcut to age-appropriate investing, though they have some shortcoming. They are focused only on your age but don’t consider other factors, such as how long you plan to work, your health, your risk tolerance, etc. Target-date funds also tend to have high management fees, so you may want to consider replicating a target-date fund’s basket rather than investing in one directly.
Keep calm and rebalance
A Fidelity analysis found that their most successful investors were those who forgot they had a Fidelity account – basically, the people who didn’t overreact to market movements. Avoid the stress of watching your portfolio rise and fall by setting up automatic rebalancing, and re-evaluating your allocation once every few years at most. In the long run, a laissez-faire approach gets much better results than constant adjustments to market conditions.
Remember you’re playing the long game
You aren’t investing for two or five years from now – you’re investing for your retirement in forty-plus years. Downturns and bull markets alike are blips on the radar; an age-appropriate portfolio allocation and regular contributions are what really matter. If you’re in your 20’s, don’t play it too safe – choose a portfolio allocation that puts your money to work.
Millennials may be investing far too conservatively when it comes to retirement accounts, but there’s some good news: they’re actively planning for their future retirements and they’re looking for a top 401(k). According to a survey from Transamerica:
- 70% of Millennials are already saving for retirement
- 2/3 of Millennials expect their primary retirement income source will be self-funded through retirement accounts
Like most of us, Millennials aren’t lazy…but want – and expect – a 401(k) plan offered by their employer will be digitally accessible, easy-to-use, and hassle-free.
What Millennials expect from their 401(k)s
If your business employs Millennials, it’s important to consider their expectations when it comes to retirement. When asked, 76 percent of millennials said that “retirement benefits offered by a prospective employer will be a major factor in their decision on whether to accept a future job offer.” In order to recruit and retain Millennial talent, employers must look for ways to provide a high-quality 401(k) that meets their employees’ needs. Start by looking for 401(k) plans that:
- deliver a digital, easy-to-use interface for participants to manage their investments
- provide access to informed advisors who offer personalized investment advice
- vest immediately and offer low rates
If you’re looking for a great 401(k) for your employees, click here to request more information about Human Interest.
Image credit: Luis Llerena
Anisha Sekar has written for U.S. News and Marketwatch, and her work has been cited in Time, Marketplace, CNN and more. A personal finance enthusiast, she led NerdWallet's credit and debit card business, and currently writes about everything from getting out of debt to choosing the best health insurance plan.