Millennials’ already stretched finances could face a new stress: slower growth of the U.S. economy. Compared with their parents, today’s younger workers may need to save more of their income for retirement, according to a new NerdWallet report.
A number of analysts predict that the continuing pattern of slower growth that has taken hold since the Great Recession could cause stock market returns to fall from 7%, the annual average since about 1950, to a possible 5% in the decades to come. And that could hurt investors saving for retirement.
The new goal for retirement
The difference of two percentage points in broad stock market returns has big implications for younger adults who are just starting to save for retirement and also for those who’ve been investing for about a decade. NerdWallet’s analysis shows that millennials, who could earn a 5% return over the bulk of their investing lifetimes, may be required to save 22% of their annual income to make up the gap. Many retirement experts currently recommend saving 15% of annual income.
“The era of supernormal returns is over,” says Martin Small, the head of U.S. iShares for BlackRock, the world’s largest asset manager. “Over the longer term, younger investors should expect yields and equity market returns to be low.”
To help a millennial investor prepare for the future, NerdWallet analyzed the saving needs of a 25-year-old earning $40,000, the median salary for ages 25-29, according to the U.S. Census Bureau’s 2015 Current Population Survey.
Based on the 7% average in stock market returns each year since 1950, a 25-year-old earning $40,000 can meet a common retirement goal of replacing 80% of his or her income by age 67 by saving 13% of annual income.
But if average annual stock market returns fall to 5%, NerdWallet’s analysis shows a 25-year-old will have to set aside 22% of annual income to save the same amount. That’s an increase of $3,400 this year — equivalent to over three months of rent, based on the median monthly rent of $937 for 25- to 29-year-old households.
How millennials can start preparing now
Start saving. In addition to saving more income, lower investment returns mean millennials may need to start contributing earlier to a retirement savings account than their parents did, or plan for longer careers. Use a retirement calculator to assess progress toward retirement goals and identify potential gaps.
Take advantage of tax benefits and employer matches. Estimates show a quarter of employees aren’t contributing enough to get the full 401(k) match. That match is free money that gets you closer to your savings goals.
Those who don’t have a 401(k) can get a tax deduction by making contributions to a traditional IRA.
Don’t stash your retirement money in a savings account. Focus first on earning your employer’s 401(k) match and setting aside at least $500 in case you need quick cash. Then, consider opening a Roth IRA account and start funneling savings into that. By investing in low-cost vehicles like exchange-traded funds and index mutual funds tied to the overall stock market, like the S&P 500 Index, your money will go to work for you over the decades rather than collecting the low interest rates of most savings accounts.