While this bear market may be a real threat to the retirement security of baby boomers, Generations X and Y may reap tremendous long-term benefits if they stick with fundamentals.
History demonstrates that most secular bear markets set the stage for the next bull market. While there are no guarantees, there is a reasonably high probability that the economy will stabilize, earnings will grow, and confidence will return to the markets. A combination of growing earnings and expanding multiples will likely be the formula for the next advance in global wealth.
We just don’t know when.
Gen X and Gen Y are under 45. I define Gen X as the cohort born between 1965 and 1980, while Gen Y as those born between 1981 and roughly 2001. Thus, Gen X has 20 or more years to go before retiring, and Gen Y has 30 or more years. This should be plenty of time to wait for the next bull market.
The hard part for Generation X and Y investors is that they have never really experienced a bull market. Many started investing within the last 10 years, and their experience has been mostly negative. Thus they are skeptical about the markets and the ability of the markets to help them accumulate wealth.
It is our job as advisers to help younger investors fight that skepticism and focus on the fundamentals of consistent savings and balanced investing. Two of the most important factors in building wealth are time and acquisition cost. The longer the time frame and the lower the acquisition costs, the higher the odds are that one’s wealth will grow.
For Generation X and Y investors, this market decline may be just what the doctor ordered. If they consistently invest small amounts on a monthly basis into a balanced and globally diversified portfolio, they are most likely laying the foundation for a significant increase in their wealth as they age.
The benefits of dollar cost averaging are quite clear from the historical record. It would have worked well for the bear markets of the late 1960s and 1970s, and even during the 1930s. While long-term returns on a dollar invested at the start of each bear market may not have been good, the long-term returns on dollars invested during the bear markets were very good.
For example, if an individual invested $10,000 a year (inflation-adjusted) into a balanced portfolio starting in 1962, over the next 20 years, the individual would have invested a total of about $307,000. By 1981, the account value would have been worth about $595,000. That’s not bad for one of the worst 20-year cycles that included a big bear market, 10 years of stagnating stock market returns and high inflation.
But the real story is what happened after 1981. Between 1982 and 1991, the individual’s wealth would have accelerated from $595,000 to over $3.4 million. By following a simple buy-and-hold approach, the investor eventually benefited from the next bull market. It just took a while.
Given the recent turmoil, it is important to instill a degree of long-term confidence in younger investors. We can do that by conveying a realistic message about the current markets and the potential for returns. Short-term, it is realistic to expect more declines and a difficult cycle. But long-term, it is realistic to expect another bull market well within the time frame for Generation X and Y investors to benefit substantially.
Acquiring wealth for retirement usually takes about 40 years. Most people start working in their mid 20s and hope to retire in their mid 60s. Consequently, the most recent cycle should not overly influence advice about long-term wealth building. During the late 1990s, investors became too enthusiastic about the future and took too much risk. Today, they are likely too pessimistic. The danger is that younger investors will either become too cautious and not participate at all, or attempt a more aggressive trading strategy that will likely lead to greater losses.
The best formula is the tried-and-true approach: using dollar cost averaging, and a balanced and globally diversified portfolio. In 30 years, the odds are that these younger investors will thank you for your consistent and prudent advice.
