(Bloomberg Opinion) – Younger investors are thinking about their investment portfolios all wrong, and it's not entirely their fault. Ultimately, it's up to them to figure out where the best long-term returns lie before too much precious time is wasted.
The mistake they are making is to replace stocks and bonds with stores of more questionable value, such as watches, sneakers and rare cars. According to one last survey from Bank of America Corp., about 94% of affluent millennial and Gen Z investors are looking to invest in collectibles, and many already do, presumably because stocks and bonds don't pay enough.
“Millennials and Gen Z tend to be interested in alternative assets,” Drew Watson, head of art services at Bank of America Private Bank, told Bloomberg News. Alternative investments traditionally referred to hedge funds and private investments in companies and commodities. It now apparently includes anything that money can buy.
But it is a mistake to think that all assets are fungible. Stocks and bonds are uniquely attractive: They take no time or effort to own; they are liquid – that is, investors can sell at any time; and with a low-cost index fund, investors can buy the entire stock or bond market and most likely generate a profit over time. Those who invest for the long term and hang on through occasional downturns have a very low chance of losing money. There is no other investment that I can say more about.
The returns are generous, especially considering the low risk for long-term investors. I'm looking at historical numbers going back almost a century for a traditional 60/40 portfolio where 60% is allocated to the S&P 500 Index and 40% to five-year Treasuries. This portfolio has returned 8.5% annually since 1926 through April, including dividends. The numbers for non-US stocks don't go back that far, but I expect the results would be similar if a global stock index were traded for the S&P 500.
There were some scary moments along the way, but they were always temporary. The 60/40 portfolio had an annualized standard deviation—a common measure of volatility—of 11.4%. In a severe downturn, a portfolio may be two to three times below its standard deviation, meaning that this portfolio has fallen about 30% at times before recovering to highs. But there were always new ups and downs.
This is as close to a sure thing as investing.
Apparently not good enough for investors. In one Natixis 2023 Survey, US investors said they expect their portfolios to generate 15.6% a year after inflation, a wildly unrealistic target and 8.6 percentage points a year more than financial advisers predict. Of the many countries surveyed by Natixis, this gap is the largest in the US by a wide margin.
Such expectations help explain why investors are unhappy with stocks and bonds, although they are unlikely to do better with the alternatives—and may do much worse. Just ask institutional investors, who have been trying to increase profits with alternatives for decades.
Yale University's endowment, which helped start the now-popular pivot away from stocks and bonds and toward alternatives, is among the few exceptions. Over the past two decades through June 2023, Yale's endowment REACHED a return of 10.9% per year, which was 3 percentage points per year better than the university endowment average.
The 60/40 portfolio, by comparison, returned 7.4% over the same time, about as much as the average endowment and arguably better than many others that were below average, despite being hampered by low interest rates for most of the time. . The 20-year average return of the 60/40 portfolio in all interest rate environments since 1926 is closer to 8.9%. And it doesn't require an army of analysts and portfolio managers chasing the “best” investments, just two or three index funds tracking broad markets.
Younger investors who diverge into other assets may fare worse than institutional ones. For institutions, including university endowments, the alternatives still mostly mean investments in private companies and commodities, whose performance on average has reliably approximated that of stocks. Not so for millennials and Gen Z. About a third of their portfolios are invested in alternatives that include collectibles and cryptocurrencies, according to the Bank of America survey. The performance of these assets as a group is difficult to track and even more difficult to predict.
And unlike indices that track the broad stock and bond markets, collectibles and cryptocurrencies expose investors to more than just volatility. There's no practical way to buy the entire art, watch or sneaker market, meaning investors are more likely to own individual pieces. And as with any individual stock or bond, the price can collapse without ever recovering.
This is the part that is not entirely the fault of new investors. Big banks used to make big money selling individual stocks and bonds, long after there was overwhelming evidence that most investors are better off with low-cost, broadly diversified index funds. There is no more money in selling stocks and bonds, so banks have turned to “alternatives” with high prices. Are the big banks offering art services because younger investors are looking to invest in art, or is art being relegated to their portfolios because bank salespeople have a quota to fill? I suspect it's the latter.
Young investors have another hurdle worth noting: About a fifth of their savings is in cash. It's great for banks because it strengthens their balance sheets and fuels their lending business, but it's a huge drag on the wallet. Adding a 20% cash allocation to an otherwise 60/40 portfolio—meaning 20% cash, 48% stocks, and 32% bonds—would have generated 7.6% per year since 1926, almost a percentage point. full less than a 60 fully invested. 40 wallets.
It may not seem that different, but it adds up over time. The difference between saving and investing $10,000 a year at 8.5% for 40 years and growing those same savings at 7.6% comes to about $800,000. Individual investors only have so much runway to grow their savings; sitting on cash or chasing speculative items can be very costly.
Millennial and Gen Z investors told Bank of America that social media is their top source for financial information and advice. Maybe it's time to put down the dopamine dispenser and do some math.
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Nir Kaissar in (email protected)