Younger investors are thinking about their investment portfolios all wrong, and it’s not entirely their fault. Ultimately, it’s up to them to recognize where the best long-term returns lie before too much precious time is wasted.
The mistake they’re making is replacing stocks and bonds with more questionable stores of value, such as watches, sneakers and rare cars. According to a recent survey by Bank of America Corp., about 94% of wealthy millennial and Gen Z investors are looking to invest in collectibles, and many of them already do, apparently 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. Now it apparently includes anything money can buy.
But it’s a mistake to think all assets are interchangeable. Stocks and bonds are uniquely appealing: They take no time or effort to own; they’re liquid — that is, investors can sell any time; and with one low-cost index fund, investors can buy the entire stock or bond market, and very likely generate a profit over time. Those who invest for the long term and hang on during occasional downturns have a very low chance of losing money. There’s not another investment I can say all that about.
The profits are generous, particularly considering the low risk to long-term investors. I’m looking at historical numbers going back nearly a century for a traditional 60/40 portfolio where 60% is allocated to the S&P 500 Index and 40% to five-year Treasuries. That portfolio has returned 8.5% a year since 1926 through April, including dividends. The numbers for non-US stocks don’t go back as far, but I expect the results would be similar if a global stock index were swapped 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 slump, a portfolio could be down two to three times its standard deviation, which means this portfolio was down about 30% at times before recovering and moving on to new highs. But there were always new highs.
That’s as close to a sure thing as it gets in investing.
It’s apparently not good enough for investors. In a 2023 Natixis 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 anticipate. Of the many countries Natixis surveyed, that gap is highest in the US by a wide margin.
Such expectations help explain why investors aren’t satisfied with stocks and bonds, although they’re not likely to do better with alternatives — and they could do a lot worse. Just ask institutional investors, who have tried to boost returns with alternatives for decades.
Yale University’s endowment, which helped pioneer the now popular pivot away from stocks and bonds and into alternatives, is among the few exceptions. During the past two decades through June 2023, Yale’s endowment achieved a return of 10.9% a year, which was 3 percentage points a year better than the average university endowment.
The 60/40 portfolio, by comparison, returned 7.4% during the same time, nearly as much as the average endowment and presumably better than many others that fell short of the average, despite being hamstrung by record low interest rates for much of the time. The 60/40 portfolio’s average rolling 20-year returns across all interest rate environments since 1926 is closer to 8.9%. And it doesn’t require an army of fancy analysts and portfolio managers chasing the “best” investments, just two or three index funds that track broad markets.
Younger investors who stray into other assets may fare worse than institutional ones. For institutions, including university endowments, alternatives still mean mostly 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 hard to track and even harder to anticipate.
And unlike indexes that track broad stock and bond markets, collectibles and crypto expose investors to more than just volatility. There’s no practical way to buy the entire art or watch or sneaker market, which means 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 isn’t entirely the fault of younger 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’s no money in selling stocks and bonds anymore, so banks have pivoted to high-priced “alternatives.” Do big banks offer art services because younger investors are clamoring to invest in art, or is art landing in their portfolios because salespeople at banks have a quota to fill? I suspect it’s the latter.
Younger investors have another hurdle that’s worth mentioning: About a fifth of their savings sit in cash. It’s great for banks because it bolsters their balance sheets and feeds their loan business, but it’s a major drag on portfolios. Adding a 20% allocation to cash in an otherwise 60/40 portfolio — meaning 20% cash, 48% stocks and 32% bonds — would have generated 7.6% a year since 1926, almost a full percentage point less than a fully invested 60/40 portfolio.
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 the same savings at 7.6% amounts to about $800,000. Individual investors only have so much runway to grow their savings; sitting in cash or chasing speculative collectibles can be very costly.
Millennial and Gen Z investors told Bank of America that social media is their primary source for financial information and advice. Maybe it’s time to put down the dopamine dispenser and do some math.
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