The golden age of investing is over, leaving young investors with a difficult set of choices and lower expected returns.
Young investors are facing a harsh reality: they will not enjoy the same returns their parents did. The past four decades were a golden age for investors, with global shares and bonds posting impressive annualized real returns. However, this era of high returns is likely over, as global trends such as globalization, declining interest rates, and quiescent inflation have reversed. Young investors must now navigate a more challenging investment landscape, grappling with how much to save, how to maximize returns in a low-yield environment, and how to align their investments with their moral values. Unfortunately, many young investors are making poor choices that could further diminish their already meager expected returns.
The End of the Golden Age
The asset-management industry’s constant reminder that past performance is no guarantee of future returns has never been more relevant. If market returns revert to longer-term averages, young investors will face significant differences in their investment outcomes compared to previous generations. Over the past eight decades, the long-run average annualized real returns for stocks and bonds were 5% and 1.7%, respectively. However, for the four decades leading up to 2021, young investors enjoyed much higher returns of $17.38 for stocks and $11.52 for bonds on a $1 investment. This stark contrast highlights the challenges young investors face in a world of lower expected returns.
The Decline of Interest Rates and its Consequences
The decline in interest rates that began in the 1980s played a crucial role in the golden age of investing. As bond yields fell, bondholders enjoyed significant capital gains, resulting in high returns. However, as yields approached zero, the potential for future capital gains diminished. In recent years, yields have climbed, further limiting the potential for capital gains. The same logic applies to stocks, where declining dividend and earnings yields led to windfall valuation gains for shareholders. These gains, however, came at the expense of future returns, leaving young investors with more modest prospects.
The Importance of Sensible Investment Decisions
Given the challenging market conditions, it is crucial for young investors to make wise investment decisions. While today’s young investors have better access to financial information and low-cost index funds than previous generations, many are falling into traps that will further erode their expected returns. One such trap is holding too much cash, which leaves investors exposed to inflation and missed opportunities for returns. Another trap is a reluctance to own bonds, despite their potential to outpace inflation. Finally, the rise of thematic investing through exchange-traded funds (ETFs) presents a new challenge, as young investors are enticed by customised products that promise to beat the market but often come with higher fees and increased volatility.
Navigating the Traps
To avoid these traps, young investors must recognize the importance of long-term investment strategies and the potential impact of their early experiences in the market. Allocating too much to cash can result in missed opportunities, while a reluctance to own bonds can leave investors without a vital asset class. Thematic investing should be approached with caution, as it often comes with higher fees and increased risk. By understanding the limitations of these traps and making informed investment decisions, young investors can maximize their returns in a challenging market environment.
Conclusion:
Young investors are facing a new investment landscape characterized by lower expected returns. The golden age of investing, driven by globalization, declining interest rates, and quiescent inflation, is over. Young investors must adapt to this new reality by making sensible investment decisions, avoiding traps such as holding too much cash, shunning bonds, and falling for thematic investing. By embracing long-term strategies and considering the impact of their early experiences in the market, young investors can navigate these challenges and maximize their returns in a world of diminished expectations.
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