We often group people as coming from a particular generation. Each generation experiences world-changing events at shared points in their lives, casting a permanent world view on their characters and outlook. Living through the Great Depression or World War II profoundly affected the lives of the Silent Generation. The Baby Boomers were especially advantaged by growth and affluence. Now, Millennials are having their lives formed by a series of events that have unfolded over the past two decades. How will their lives be changed?
If you are part of the Millennial Generation, you might be asking, “Is this the unlucky generation?” The first wave was just graduating high school or college when the tech bubble burst between 2000 and 2002. In the years after, low interest rates and easy credit fueled a housing bubble, which burst in 2008 and brought on the Great Recession. Many Millennials had taken on record amounts of student debt to finance a college education only to find limited career prospects and relatively low wage rates. Now, in 2020, the Millennials aged 24 to 39 are just starting to form families and raise children. Who could have imagined that yet another disaster would engulf them in the form of a global pandemic?
For the most part, other generations persevered through economic cycles relatively well. The Silent Generation was extraordinarily frugal and had saved and invested in real assets like houses and businesses. When the great inflation came in the seventies they saw their incomes erode, but the value of their assets, particularly their homes, allowed them to live well in retirement.
It seems that luck chooses whether to put these generations at the right place at the right time. In wealth management, we call this sequencing. Everybody experiences bad events in their lives, but the order and magnitude of these events has a profound effect on the final outcome. For Millennials the sequencing could not have been worse.
A recent study by the Federal Reserve shows that persons born in the 1980s had very little exposure to the housing bubble that started the Great Recession and did not participate in the subsequent recovery. Also, this generation had more debt but less mortgage debt. The personal debt of this generation is tied to college loans and credit cards. Neither of these will be getting relief from the current run up in stock market prices. So for Millennials it was a lost decade of missing out on a housing boom and then falling into another recession carrying too much debt.
So, what happens next? This depends on income and ability to save over future decades. With the national unemployment rate over 12%, people are becoming excessively cautious with their money. Personal savings rates have skyrocketed from 8% to 23% on income this year. Unfortunately projections on future rates of return are also declining.
The truth is, nobody knows what happens next. Even though we know sequencing is important, we can't control it.
Is there a way to defeat sequencing in your wealth accumulation?
Fortunately there is a proven financial strategy that can defeat sequencing. It was developed several hundred years ago and is called pooling of risk. This is the method used by insurance companies and pension funds to provide benefits across generations.
Under this strategy, savings are pooled over a large number of participants and over a long time period. No one individual bears the risk of an adverse event at an inopportune time. The savings and the risks are pooled across all the plan participants.
Millennials in the PERA Defined Benefit Plan are contributing savings into a pool of assets that will accumulate wealth and provide an income stream at retirement. The risk to a single participant is shared across a pool of tens of thousands of individuals who all will be contributing and drawing income at different times. This removes the risk to any one person that they will hit any number of “unlucky” events at an inopportune time. Contribution rates and the benefits members receive are all defined by the plan and not dependent upon market forces in any individual year.
We don’t know what the future will bring. But we do know that being in a defined benefit pension is an effective way to sidestep many of the risks that unlucky sequencing can bring to your retirement plans.