Let’s call it the millennial paradox. You’re in your 20s, and suddenly, you’re actually making money. The problem is that something or someone is after every single dollar. You need to pay off your student loans; you need to cover your living costs. You need to save for the short term – the next vacation; an emergency fund – as well as for your retirement. Maybe you’re helping out a family member, as well.
The worst of it all is that probably all of these demands on the finite number of dollars you’re making are just as important as each other.
And then along comes the Financial Times, with a survey concluding that – tsk, tsk, tsk – millennials are prioritizing short-term spending over long-term saving. According to one calculation, the average 25-year-old should be saving £800 (or about $1,146) a month over the next 40 years, in order to retire at 65 with an annual income of £30,000.
That piece went viral. For all the wrong reasons. As millennials who responded angrily, or flippantly, to the article noted, they’re too busy buying groceries or paying rent to even think about being able to have that much money to allocate to a savings account. But ignoring the tone deafness, there is a real problem here.
T Rowe Price recommends that millennials should save about 15% of their incomes for retirement. However, a recent survey found that on average, while they are doing a good job of budgeting and say they have increased their savings in the past 12 months, their actual savings rate is about 8%.
Financial planners can huff and puff about results like that. They can argue that millennials don’t realize how much they need to save; that they are succumbing to one of those behavioral finance phenomena by failing to appreciate that yes, one day they, too, will be 65 and need a retirement nest egg. For their part, the millennials might well argue that the rest of us simply don’t understand their new normal.
It has always been true, and remains true today, that a dollar someone puts aside in a tax-sheltered retirement account when he is 25 years old will be worth much, much more then that same dollar would be if he had set it aside at the age of 50, thanks to the fact that it is sitting there are being reinvested, year after year, tax-free. (It’s called compounding.) What someone in their 20s loses in absolute wealth, they earn in terms of time. A case in point: if you’re 20 today, and put $1 aside, and it earns the historical 6.6% return (inflation-adjusted) that the Standard & Poor’s 500-stock index has captured, by the time you’re 65, that single dollar will have become $18.50. You do the math. If you put aside the same dollar at 30, by 65 it’s only worth $9.60 – you’ve lost half of the potential gains.
The problem is that there are too many other factors stopping millennials from making that decision to save.
Some of them, admittedly, are structural. You have to work for a company that offers a 401(k) retirement plan; automatic enrollment should be a given, and the default contribution level should be at a reasonably high level. Then, too, employees need to be encouraged to take advantage of all the money that companies offer in matching 401(k) plan contributions: currently, they’re leaving about $24bn a year on the table. More new plans need to be devised for self-employed individuals and others who can’t take advantage of these 401(k) plans that give them the chance to save just as much on a tax-free basis.
But even if you’re a millennial working for a company that gives you a 401(k) plan with an excellent match, you’ve got the millennial paradox to contend with: all the competing demands on your dollars, just when you know that if you put them to work in your retirement account, they’d do you the most good. But really, what are you going to cut from your budget? Where is the fat?
In 2014, the average college student graduated with $33,000 of student debt, according to one calculation: even on an inflation-adjusted basis, that’s more than double the level of debt members of the class of 1994 had to deal with. Do you want to be one of those students who defaults on her student debt, goes AWOL and moves to a foreign country – preferably one with no extradition treaty with the United States – just in order to have a few extra bucks to put into her retirement account? Just where were you thinking of retiring, anyway? Ecuador? Really, not a viable solution; those payments have to be kept up, even if it means there’s no money for a retirement account.
The cost of living is climbing, too, led by rental costs, which hit records in many American cities last year. On average, millennials who rent nationwide would have had to spend 30% of their monthly income to their landlords, according to a Zillow survey, with figures going as high as 47% in San Francisco, 45% in Miami and 41% in New York.
Health insurance? If your company offers it, odds are it’s a benefit that requires you to shoulder a greater portion of the costs of these days. And if you’re older than 26, and paying for your own healthcare, you’ve already discovered that both premiums and deductibles are rising for most policies.
Then, too, there are rites of passage. A friend gets married, and invites you to be in the wedding party. That means you’ll need to invest to buy a dress or rent a tux; throw your friend a party beforehand; travel to the wedding – and be prepared to fork over for a handsome gift.
Eventually some of those pressures will abate – the student debt will be paid down – and millennials will be earning more. But they will be older, and the value of each dollar they save by that stage will be less. In any event, new financial pressures will arrive on the scene, in the form of children, the need to save for a house, to help out aging parents.
Perhaps there is some creative way to tackle this. To the extent that the cost of obtaining an education means that millennials can’t start saving for retirement when it’s most advantageous for all of society that they should, maybe there’s a way to restructure or postpone debt payments until later in life as long as graduates begin contributing to their retirement accounts.
The worst of all possible outcomes would be for the scenario painted by the Financial Times to become a self-fulfilling prophecy: for millennials to conclude that the targets mentioned by financial planners (whether $1,100 a month, or 15% of their income) are so far out of reach that there’s simply no point in trying, so why not just blow your spare money on holidays and nights out with friends. Because, you know, YOLO …
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