Avoiding the Stock Market May Cost Millennials $3.3 Million
By Arielle O'Shea and Stephane Lesaffre
Research suggests millennials have largely resisted investing, instead favoring “safe” vehicles like savings accounts and plain cash. A new NerdWallet analysis puts the potential cost of avoiding the stock market at over $3.3 million in lost retirement savings by the time today’s 25-year-old millennial retires at 65, assuming future economic and market conditions don’t veer sharply from historical averages.
The long-term story (of investing) is something millennials ignore at their own risk.
Today, one can easily and cost-effectively achieve diversification via index funds.
Annual savings were calculated as 15% of income for a 25-year-old with a starting salary of $40,456, the median for 25- to 34-year olds according to Bureau of Labor Statistics weekly earnings data. The salary was increased annually by 3.7% for inflation, based on average consumer price index data for the time period studied. A consistent 15% savings rate was used to meet a common rule of thumb from financial advisors.
Nominal returns were calculated using the 40-year period from the close of 1976 to the close of 2016. Investment returns are based on nominal Standard & Poor’s 500 returns over that time, with dividends reinvested. Nominal three-year Treasury bill returns were used as a proxy for savings account interest rates, which were unavailable for the full time period analyzed.
We calculated accumulation in two ways:
- We took the geometric mean of each year’s S&P 500 return and annualized three-month Treasury returns over the 40-year period, and then applied those to a 25-year-old beginning to invest today.
- We ran a Monte Carlo analysis to simulate potential median returns over the 40-year horizon, based on the historical mean return and standard deviation of the S&P 500 and three-month Treasurys.
The average annual S&P 500 return as calculated by the geometric mean was 10.96%, and the average annual three-month Treasury return was 4.61%, which we rounded to 4.6%. Compounding the hypothetical investor’s annual contributions over 40 years using these historical mean returns results in the investor having $4.57 million when invested in stocks, versus $1.27 million when investing in a savings account or three-month Treasurys. The Monte Carlo simulation returned a 50% chance of ending up with at least $4.95 million in the stock market. We chose to use the smaller number as the primary result.
The stock market investment return was reduced by fees, calculated as 0.70% annually, based on the rounded average of 15 years of 401(k) mutual fund expense ratios, as reported by the Investment Company Institute.