The next generation of investors must navigate a challenging investment landscape with lower expected returns and changing market dynamics.
Young investors and those just starting to save face a unique set of challenges in today’s investment landscape. While there are timeless lessons to be learned, such as starting early and diversifying, the reality is that the golden age of high investment returns enjoyed by previous generations is likely over. The combination of globalisation, declining interest rates, and quiescent inflation that fueled decades of strong returns has reversed, leaving young investors with a more difficult set of choices. This article explores the implications of lower expected returns, the dangers of chasing hot assets, and the importance of making informed investment decisions in a changing market.
The End of the Golden Age
The past four decades have been a golden age for investors, with global shares posting an annualized real return of 7.4% and global bonds returning 6.3% annually. However, this era of high returns is likely coming to an end. Factors such as globalisation, declining interest rates, and quiescent inflation that contributed to the golden age have reversed, creating a more challenging investment environment for young investors.
The Danger of Unrealistic Expectations
Young investors must be cautious not to base their expectations on the unusually high returns of the past. If market returns revert to longer-run averages, the difference for today’s young investors could be significant. It is crucial for them to save enough for retirement and not rely solely on investment returns to make up the difference.
The Decline of Bond Yields
The decline in bond yields over the past few decades has been a significant driver of high returns for bondholders. However, as yields approach zero, the potential for future capital gains diminishes. Recent increases in yields have further limited the potential for future gains, making it unlikely that young investors will enjoy the same returns as previous generations.
Dim Outlook for Stocks
While stock prices have experienced a strong recovery after the market downturn in 2020, the long-term outlook for stocks remains uncertain. The equity risk premium, which measures the expected reward for investing in risky stocks over safe government bonds, has fallen to its lowest level in decades. Without sustained earnings growth, young investors may face significant market volatility or years of disappointing returns.
Traps for Young Investors
Young investors face several traps that can hinder their investment returns. One common trap is holding too much cash, which leaves them exposed to inflation and missed opportunities for higher returns. Another trap is a reluctance to invest in bonds, which historically offer higher yields than cash and tend to outpace inflation. Lastly, the rise of thematic investing and the marketing of ESG (environmental, social, and governance) funds can lead young investors to make suboptimal investment decisions based on short-term market trends and perceived ethical considerations.
Conclusion:
The era of high investment returns enjoyed by previous generations is likely over, and young investors must navigate a challenging investment landscape with lower expected returns and changing market dynamics. It is crucial for them to avoid common traps, such as holding too much cash and overlooking the potential benefits of bonds. Making informed investment decisions and setting realistic expectations are key to maximizing returns in a low-return market. While the future may seem uncertain, young investors have access to more financial information and investment tools than ever before, giving them the opportunity to make the most of their investments and secure their financial future.
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