Introduction
Don’t be fooled by the recent gains in the stock market or its impressive recovery since the financial crisis. The truth is that we have been in a low-return environment since the burst of the Internet bubble at the turn of the millennium, and there is little indication that things will change any time soon.
The Need to Save More
Retirement savers can no longer rely on the markets alone to secure their financial future. They need to save more, and by a significant amount, according to a report from BlackRock, a leading asset manager. In the past, it was recommended to save 10% to 15% of one’s pay. However, the new reality is that Millennials must save 25% of their pay for 40 years to achieve the same level of financial security that was enjoyed by boomers, who saved only half as much.
Anne Ackerley, head of BlackRock’s U.S. and Canada defined contribution group, emphasizes the importance of taking action now to benefit from compound interest over time. Another analysis by Nerdwallet suggests that Millennials need to save at least 22% of their pay to ensure a comfortable retirement.
The Challenge for Millennials
These figures may seem daunting, especially considering that young workers currently save only about 6% of their pay. Increasing that to 22% or 25%, even with employer matches, may seem impossible for many. Millennials often face higher housing costs and significant student loan burdens. However, Ackerley reassures that the 25% savings rate is not set in stone; it’s an estimate based on historical data and future projections. Additionally, it assumes that there will be no Social Security, which is unlikely. Nevertheless, the underlying message remains: Millennials need to save twice as much as boomers to achieve similar outcomes.
Reasons for Lower Returns
If you have a short memory, you might question why BlackRock is making such claims. After all, the S&P 500 has shown impressive gains since the election and has more than tripled since the lows of the financial crisis. However, the reality is that since the end of the last bull market in 2000, the average annual return of the S&P 500, including dividends, has been only 4.3%, or 2.2% after accounting for inflation. BlackRock predicts that these average returns will persist for the foreseeable future.
Why is this the case? BlackRock’s research indicates that the working-age population is slowing down in developed economies, resulting in decreased demand for goods and services. The global economy is also experiencing a slowdown, which impacts corporate profits. Additionally, technological advancements are disrupting established industries, leading to reduced spending on equipment, workforce, real estate, and other assets.
The Importance of Starting Early
Since the inception of 401(k) plans in 1978, a portfolio consisting of 60% stocks and 40% bonds has yielded an annual return of 6.3%. This favorable period provided boomers who had the foresight to save (many did not) with an excellent opportunity to prepare for retirement. However, the 90-year average annual return stands at just 5.1%, highlighting the exceptional circumstances enjoyed by boomers.
In contrast, BlackRock estimates that going forward, the average annual portfolio growth will be a mere 2.9%. While inflation is expected to be low, it will not be low enough to offset the challenges of building a nest egg. The firm found that an additional one percentage point of returns each year would result in 25% more savings over 40 years for the average Millennial. Similarly, with an extra two percentage points of annual return, their savings would be 58% larger by the age of 65.
Taking Action: Saving More and Planning Ahead
These estimates underscore the need for young people to start saving early, take some risks with stocks, and increase their contributions each year until they reach a minimum savings rate of 15% of their pay. Planning to work longer is also advisable, although it may not always be feasible.
Furthermore, these findings put pressure on plan managers to simplify saving guidelines and make it harder for employees to opt-out. BlackRock suggests implementing changes such as higher default contribution rates, requiring employees to contribute more to receive the full match, automatically enrolling older workers in “catch-up” programs that allow for increased tax-deferred savings, and tightening restrictions on loans and early withdrawals.
Saving for retirement may seem overwhelming, but taking the steps outlined above can make a significant impact on securing a comfortable future. Remember, the key is to start early, save diligently, and make informed decisions to navigate the challenging investment landscape ahead.
A visual representation of the importance of saving for retirement
