Young people stand to make dismal returns on their investments

"HAVING BEEN born into the most prosperous period in human history, today's youngsters have much to hope for. But they have much to fear as well. On top of an inherited climate crisis, the young will have to suffer the economic consequences of a pandemic. For "Generation Z", those born after 1997, this could mean higher rates of unemployment, lower earnings and higher taxes to pay off pandemic-era debts. Add to this unhappy list a less-noticed but no less serious problem: Generation Z's dismal financial prospects. According to Credit Suisse's latest, Generation Z's earnings from stocks and bonds will be significantly lower than those of previous generations.

The report's authors, Elroy Dimson of Cambridge University and Paul Marsh and Mike Staunton of London Business School, begin by looking at average investment returns since 1900. They estimate that baby-boomers (defined here as those born 1946-64), Generation X (born 1965-80) and Millennials (born 1981-96) have all earned average real returns of at least 5% on equities and at least 3.6% on bonds. The authors then forecast what Generation Z might expect to earn in the coming decades. To do this, they assume that the real return on equities will be equal to the inflation-adjusted return on a risk-free asset (represented by Treasury bills), which they estimate at -0.5%, plus a "risk premium" for buying equities of about 3.5%, for a real return of just 3%. For bonds, the authors assume the current, negative real yields on the index-linked variety. All of this adds up to annualised returns for Gen Z of a mere 2% on a 70:30 portfolio of stocks and bonds--not even a third of the historical return of the baby boomers (see chart). These guesses could prove too pessimistic, but perhaps not dramatically so. The authors concede that a serious bout of deflation could drive up bond returns. But currently inflation, not deflation, is the worry.

What can Gen Z-ers do to mitigate the damage? For starters, they should not "calibrate off the past", says Mr Marsh. To have any hope of retiring as comfortably as their parents, they will have to save more. Mr Marsh recommends adopting the time-honoured (if unexciting) principles of long-term investment, including starting early, diversifying risk and avoiding high management fees. Rather than checking the value of their investments every ten minutes and trading frantically, they should exercise patience and sit out temporary shocks and turbulence. "Gen Z needs to go against the grain of what comes naturally to them," Mr Marsh says.

Young investors must not draw ill-advised lessons from the pandemic, either. Having plummeted during the early months of the outbreak, stocks quickly bounced back. Crashes are rarely so fleeting, and Gen Z should recognise this, says Mr Marsh. "Equity markets are risky and this time we got lucky." [1]

1. "Young people stand to make dismal returns on their investments; Daily chart." The Economist, 15 Mar. 2021, p. NA.