Bad Advice for Younger Generations

Young couple I read a Wall Street Journal article recently written by a reporter for whom I have a great deal of respect, but who acted as a conduit for a fundamentally flawed (supposed) majority opinion on the part of some financial advisors—that risk taking in investing and financial planning naturally leads to reward.  The article is entitled, “Take some chances, Gen X,” and chides 30-somethings for making capital preservation an investment priority, warehousing cash in defense of a job loss and eyeing debt elimination as a goal.

Hmmm.

I’m not denying the relationship between risk and return.  But while it is true that higher returns are accompanied by a greater degree of risk, the inverse is not promised.  It’s a classic investing blunder to presume taking higher risks will naturally result in a higher rate of return.

Is it possible that while the boomer advisors were pining over outdated investment “science” and Monte Carlo retirement simulations, they missed the simple math their younger clients discovered—that it’s easier to lose money in the market than it is to make it?  If you’ve lost 10% in your portfolio, it will take 11% to get back to where you started.  If you’ve lost 20%, you’ll need to make a 25% rate of return.  If you, however, get slammed by a 50% loss, you need to make a 100% rate of return to recover your losses.  Is it possible that youth and a stomach for losses isn’t actually the optimal investing posture?

The article wisely captures the reasoning behind the financial common sense of younger generations—“Many Generation X and Y investors have watched plunging financial markets destroy their parents’ retirement plans.”  That sounds eerily similar to words spoken by Gen X’s grandparents, the Depression Babies.  While it certainly is true that the intense, deep pain of the Great Depression may have created a syndrome in which some were too conservative, the Greatest Generation’s aversion to debt, skepticism of equity-heavy investing and penchant for emergency cash reserves may be exactly the foundation young investors need for a fruitful future.

The apparent concern of the "advisors"?  (And I’m sure it has nothing to do with the fact that they can’t charge fees and commissions on cash stored for emergency reserves or used to pay down debt…) They’re “…concerned that the low risk tolerance of some of these investors may ruin their retirements too, by leaving them short of funds when they get there.”  Again, the advisors miss the mark.  The point of financial planning and investing is not to retire, but to live a better life now and in the future.  Gen Xers, realizing they may be working indefinitely, thanks to companies and a federal government that raided their retirement promises (pensions and Social Security), are choosing jobs they love over those that pay the very most and seeking the nuanced balance between saving for the future and the present and everything in between.

Maybe the article should have been headlined, “Generation X shows more financial wisdom than financial advisors.”

Tim Maurer, CFP®

Financial Planner and Gen Xer

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11 thoughts on “Bad Advice for Younger Generations

  1. Doesn’t our economy benefit if there are some risk-takers? It’s sorta an injection of cash into the whole thing that’s not from the gov’t. I’m probably wrong about this, but that’s why I would think before reading your post.
    Maybe I view the money world as a zero-sum game. If a risk-taker loses money, then someone else has got it. That money is not lost – just with another person. And part of me is ok w/ that.
    Please straiten me out if I’m thinking poorly here…

  2. Your thinking requires very little straightening, Brody. I’m not recommending against risk-taking, just the blind pursuit of risk based on the assumption that risk-taking automatically results in a long-term benefit. I’m not promoting fear or paranoia…just wisdom.
    (BTW, I know what you mean, but the money world is definitely NOT a zero sum game. Our government’s primary method of stimulus the last few years has been simply to print money!)

  3. Tim,
    I couldn’t agree more with this post. The conventional wisdom that higher risk automatically results in higher reward is a myth that has to be broken and removed from the investing world.
    The math of compounding is critically important for any investor to understand, and most importantly, investors must gain an understanding of how large negatives impact the equation. As you have pointed out, Tim, they hurt your ability to grow wealth far more than outsized gains help. This is precisely what Buffett means when he recites his two rules of investing:
    1) Never lose money
    2) Never forget rule #1
    It is far more important for investment success to keep an eye on capital preservation first. That doesn’t mean you can’t put some assets at risk, but the headline of “Take some chances” is sending the wrong message.
    To your point, Brodybond – in general, you are correct. However, when the market is flooded with leverage as it has been the last several years, we are dealing with a lot of “phantom” dollars – there has been a lot more money “in play” than actually exists. When that happens, it is no longer a zero-sum game because the losses are inevitably going to outweigh the gains. Put another way, the risks outweigh the benefits and you simply are not being rewarded properly for the amount of risk you are taking.
    Respectfully,
    Joe Pitzl, CFP®

  4. Tim,
    Love this “The point of financial planning and investing is not to retire, but to live a better life now and in the future.”
    But I’m confused on what you’re saying about the stock market.
    “that it’s easier to lose money in the market than it is to make it?”
    Could you clarify your thoughts on the stock market? Are you saying people should not invest in the market, and, if so, where do you recommend?
    Thanks!

  5. Tim-
    I get the government printing money thing means that we’re not in a true zero-sum game. But on a micro level, is it unhealthy for me to look at is as zero-sum?

  6. Great question, Paul! I’m certainly NOT suggesting that people shouldn’t invest in the market–simply that they should not expect the market to be a benevolent supernatural force with a mandate to make us money. In other words, the damage done by market losses is powerful and should not be underestimated or discounted.

  7. And Brody, regarding the health of viewing money as a zero-sum game, one danger is that some develop a scarcity mindset–leading to paranoia and hoarding. It doesn’t sound like you’re there, but that is one downside. I actually think your zero-sum concept can be helpful in market investing…recognizing that for every buyer, there is a seller and vice versa. In that sense, market investing does become closer to a zero-sum game.

  8. Tim, thanks for the clarification.
    With the recent Prudential survey indicating 44% of Americans plan to avoid the stock market, I’m concerned people will not realize the importance of investing in the markets (granted, I do not recommend trading individual stocks and prefer mutual funds or exchange traded funds for most investors).
    When I was a trust officer and private banker, I never had a high net worth client who bought into the fears created by the Great Depression. Their parents, and they, invested for the long term and benefited as a result.
    Stocks are long term (10+ years) but it’s hard not to measure them, and react, on a short term basis. That is why I agree with your observation, “that it’s easier to lose money in the market than it is to make it?”. It isn’t the market, it’s the investors ability to control their reaction to volatile markets and down markets.

  9. Paul, I’m glad we can find agreement…even if for slightly different reasons. While I agree that investors’ ability to control their reaction is paramount, I also believe that limitless optimism can be as dangerous as irrational fear of the market. Thanks so much for your contributions!

  10. Good stuff Tim. Love the line: “…while it is true that higher returns are accompanied by a greater degree of risk, the inverse is not promised.” If accepting higher risk always resulted in higher returns, then it wouldn’t be higher risk. It’s the logical equivelant of noting that all dogs are animals; and all cats are animals; and then declaring that all dogs are therefore cats.

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