Via ConvergEx's Nicholas Colas,
Which profile fits a money manager’s ideal customer – a “Mass affluent” 50-year old or a dead broke 20-something? The wealth management industry would do well to run the numbers, because it is the latter that will generate a larger fee stream over time.
How can that be? The short answer is that millennials will live longer, require far more in retirement savings, and use more high margin investment products for longer than their parents’ generation.
This simple calculus seems beyond the reach of an industry that still commonly features high minimum balances for advisory services and does little in the way of outreach to younger customers. So called “Robo-advisors” have begun to gather up this group of younger investors, but there is still plenty of time for the traditional money management industry to service this next, much larger, wave of customers.
Note from Nick: I am 51; Jessica is 21. I have a lifetime of savings, equity in a house, and disposable income to invest. Jessica has a lot of talent and a few thousand dollars saved from her 2 years of full time work. And when I see advertisements for money managers, they all clearly target me. Turns out that is a bad strategy, because the industry will make a lot more money from Jessica than they ever will getting my hard earned shekels to manage. Read on for the whys and wherefores…. And just how much more valuable millennials are than old folks like me.
Are you more afraid of death or poverty? This may seem like an odd question with an obvious answer: the Grim Reaper should engender more fear than an overdraft charge. Surveys, however, surprisingly suggest that poverty weighs heavily indeed on many people’s psyches in light of longer life expectancies and uncertainty about Social Security payouts. Consider these findings:
Sixty-one percent of respondents to a 2010 Allianz survey of 3,257 people said “they were more scared of outliving their assets than they were of dying”.This figure increased to 77% for those between the ages of 44 and 49, and as high as 82% for those “in their late 40s who had dependents”.
Moreover, 58% to 60% of all participants “worry about longevity”. One cause of financial stress relates to Social Security benefits: “39% feel they're more likely to be hit by lightning than to get their full due from Social Security. For middle-class respondents, this number rose to 56%.”
A 2014 survey conducted by Wells Fargo of 1,001 middle-class Americans (aged 25-75) said “they would rather ‘die early’ than not have enough money to live comfortably in retirement”.
Despite this fear, “61% of all middle-class Americans, across all income levels included in the survey, admit they are not sacrificing ‘a lot’ to save for retirement”. Younger adults either don’t save or push it off: “More than half (55%) … say they plan to save “later” for retirement in order to ‘make up for not saving enough now.’ For those between the ages of 30 and 49, 59% say they plan to save later to make up retirement savings, and 27% are not currently contributing savings to a retirement plan or account”. Yet, “72% of all middle-class Americans say they should have started saving earlier for retirement, up from 65% in 2013”.
This misguided plan to save later as a means to make up for lost ground in the present circumvents the benefits of compounded returns over time. With that said, young adults are at a disadvantage when taking it upon themselves to hire a financial advisor at a major financial services firm. Minimum investments typically start at $25,000, a large lump sum for millennials trying to pay off record levels of student loan debt. Automated financial advisors have disrupted the banking industry by offering passive money management with lower fees and low/or no minimum investment. The difference between a traditional wealth management firm and robo-advisors boils down to the latter’s ability to realize the future potential earnings power of millennials despite their current cash-strapped state. There’s a lot more to the model that that. No human advisors, a different investment approach, that appeal to tech-savvy millennials.
Now, it is fair to ask why the traditional money management industry should care about a bunch of millennials with minimal savings, lots of college debt, and uncertain economic futures. The answer, which we will outline in the remainder of this note, is that they are actually worth more today than a typical 50 year old “Mass affluent” customer. We undertook an exercise to compare the current value of millennial customers versus baby boomers. Our findings showed that the industry’s focus on Baby Boomers is shortsighted, and a typical millennial will be a far more profitable customer over time. Here’s an outline of the math:
Assuming 2% inflation – the Federal Reserve’s current target – over the next 50 years, or when millennials enter retirement, they will need to withdraw about $270,000 per year from their retirement plans. That’s the equivalent of $100,000 today adjusted for inflation 50 years from now, as we assume millennials will retire at age 70. By contrast, the remainder of baby boomers will likely retire at age 67. Adjusting for 2% inflation for the next roughly 15 years off a $100,000 base today suggests they need to withdraw about $135,000 per year in retirement.
Given these withdrawal figures, we also took into account that millennials will likely live until 100, and baby boomers until 85. Therefore, the former cohort will need to invest their savings to support withdrawals of $270,000 each year for 30 years, and the latter group $135,000 for roughly 18 years.
In the case of millennials, we fully invested their savings in equities from the age of 21 to when they retire at 70. We also applied a 7% annual growth rate in equities and accounted for a 1% management fee. Come their 71st birthday, we split their portfolio into a 50/50 stock to bond mix with an annual return of 7% for stocks and 3% for bonds. Rather than adding money, we adjusted for distributions of $270,000 per year.
In order to amass enough capital to keep our model millennial out of the poor house until age 100, we estimated a savings plan that gradually increases over the years as their earnings power grows. During the first 5 of the 50 potential years of work, millennials will need to save at least $1,000 annually, or about $83 per month. This may seem arduous currently in light of student loan payments in addition to other expenses like rent, but every little bit as early on helps in the future. This number must rise to $10,000 during the subsequent 5 years as their careers get underway, and $20,000 by age 31 for another 5 years. Once they reach age 36, millennials need to contribute $25,000 into their savings plans until retirement. This will leave them with about $275,000 at the end of their century-long lives.
As for baby boomers, we constructed a portfolio consisting of only equities from the age of 50 until retirement at 67. We started them off with preexisting savings of $455,000. We also used the same management fee (1%) and expected equity returns (7% annually) as we did for millennials, and added $22,000 to the savings pot annually from age 50 to 67 (or the maximum contribution allowed into a 401k plan for that age and up). Accounting for a 50/50 split between stocks and bonds in addition to withdrawals of $135,000 during baby boomers’ 20 years of retirement, they’d end with just over $20 grand at age 85.
With a 1% management fee for equities and a 0.25% management fee for fixed income, millennials represent a fee stream totaling +$1.2 million customers for money managers in total terms, and +$450 K in current figures over their lifetimes of investing. By contrast, baby boomer customers will only earn the money management industry +$300,000 in total, or +$220,000 in today’s terms for the remainder of their lives.
In sum, financial services firms may not earn high fees during the beginning of millennials’ careers, but should appreciate the benefit of this cohort as customers in addition to baby boomers. They could gain more than $800,000 (+$200,000 today) in the long run by serving a millennial. We also recognize that the savings we attributed to the latter years of a millennial’s career exceeds the current annual maximum of $18,000 in a 401k plan. We expect this to lift in order to help millennials keep up with inflation and meet their retirement goals. In the meantime, automated financial advisors, such as Wealthfront and Betterment, will continue to build their product offerings in order to exploit these inefficiencies and scoop up millennial customers before they are worth traditional money managers’ time.
