That's the question the head of the world's largest mutual fund company asked in a speech last week. William McNabb, president and chief executive of the Vanguard Group, told an audience at the Morningstar Investor Conference in Chicago that a growing number of Americans are unwilling to invest in stocks or stock funds because their faith in the financial system has crumbled.
"We are on the brink of losing a generation of young investors," McNabb said. "As I talk with young people, I hear it. They don't like this volatility." And their belief in the system has been shaken by everything from the collapse of Lehman Brothers in 2008 to the "Flash Crash" in May.
The stock market started the second quarter on a strong footing but it's ending with a whimper as investors cope with less government stimulus and the prospect of slower global growth. Where does it leave the outlook for markets in the third quarter?
In truth, every generation has moments when it suffers through a crisis in confidence. But past generations lived in a different environment, and typically were able to see events that brought them back from the edge. That's why the current situation is so alarming: nothing on the horizon appears to have the potential to attract young investors to the market.
After the market malaise of the late 1960s and early 1970s, interest rates moved to double digits, which attracted savers and brought assets into money-market funds. By the 1980s, as rates were returning to normalized levels and savers were looking for a little more, the market entered a long bull cycle that barely was disrupted by Black Monday in 1987, the build-up to the Gulf War in 1991 and other life-changing events. Even the bear market that popped the Internet bubble was answered with a mid-2000s rebound.
Moreover, the last time a generation stayed mostly out of the market, a life's work was rewarded with a pension. Now people are largely responsible for their own retirement through 401(k) plans and other savings vehicles. That makes the danger of losing a generation of young investors bigger than in the past, because it's hard to see how they will adequately grow retirement savings without a lifetime of the long-term benefits of investing.
The issue, of course, boils down to capturing the long-term benefits of investing at a time when the short-term picture is ugly and emotions are dominated by current events.
"This is a generation with a very short attention span," said Herbert Daroff of Baystate Financial Planning in Boston. "They're used to changing the channel whenever they don't like what they see. A 10-year time horizon, for them, is very long-term, when in fact they need to be investing for 20 or 30 or 40 years or more.
"This is also a generation of six-digit college loans, where many people start off their financial life in a deep, deep hole," he added. "If what they understand right now is that they will be better off paying off their college loans than putting something into the 401(k), at least they will be making progress. But there must be a way to give them hope for their future."
There's not a lot of good feeling and hope in the market right now.
The last decade's stock market performance has been rough and flat, so there is plenty of talk about how people spent 10 years earning nothing, which seems right, but probably isn't.
For starters, market indexes don't factor in dividends, which have generated some income despite the decade of doldrums. Secondarily, diversified investors had big chunks of money invested outside of the Standard & Poor's 500-stock index (MARKET:SPX) , which is the proxy for "the market" in these discussions.
"Only the S&P 500 was flat for 10 years, nothing else," explained Judy Shine of Shine Investment Advisory Services in Lone Tree, Colo. "But since no one who really invests and diversifies had a portfolio that was all S&P 500, you don't actually know people who lost a decade. They may feel like it -- I always say if you poke our clients in the right place, they still scream over the pain of the tech wreck -- but they have done better than they think or feel."
Dividend drivers
Many experts believe the next decade will be more about finding solid dividend yields that generate consistent returns while the market is waffling and direction-less. With interest rates at historic lows, dividend yields can be a way to goose a portfolio's returns, although they can be hard to hang on to when there is no capital appreciation -- or even near-term downturns -- to go with them.
What's more, dividend yields are attractive at these levels only for as long as Congress keeps taxes low. Qualified dividend income is taxed at a maximum rate of 15% under current law, but unless there's an extension or new rules are enacted -- the Obama Administration has proposed a 20% tax rate -- dividends will be taxed at ordinary income rates in 2011. That will make dividend yields much less attractive, further confounding investors on what to do now and next.
McNabb's point in Chicago is that the financial services industry can only win back investors by proving that it's trustworthy. That's increasingly difficult at a time when the long-term investor feels like the corporate community is skinning him a penny here and there every day. In fact, the only thing that historically wins investors is strong returns.
While I do believe the market will reward long-term investors, I can't blame younger generations for not being able to see it. Their experience suggests that they are better off on the sidelines than in the market.
http://www.marketwatch.com/story/story/print?guid=24FC3883-1C40-4B4F-9616-3BCDCB5C5BA9
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