Financial headwinds are facing millennials. What can we do to secure our financial future?
Every generation is shaped by the circumstances that surround it, and we’re no exception. We either started our careers during the great recession in 2008, or we started our careers in the aftermath of it. In 2019, the Deloitte Global Millennial Study found that in developed markets, only 18% of millennials expected economic improvement in their country in the next two years. That was before the COVID-19 pandemic ravaged economies across the globe. In the same study, slightly more than half of millennials thought their personal financial situations will worsen or stay the same, while 43% anticipated an improvement in the next year. In the 2018 Bank of America Better Money Habits Millennial Report, it states that one in four millennials worry often about their finances. As someone who is interested in personal finance, I wanted to take a deep dive into why my generation has such a bleak outlook when it comes to their personal finances.
Being the most educated generation comes at a price.
Millennials are the most educated generation in history, a distinction that should have made them rich and secure. Millennials are choosing to pursue a higher education because that’s what the labour market is rewarding. In 2019, the Department for Education published figures that showed working-age graduates aged 16-64 earned a median salary of £34,000 in 2018, while their non-graduate peers who choose a different path earned a median salary of £24,000. The statistics also showed that 87.7% of graduates are in employment compared with 71.6% of non-graduates. With this increased demand for higher education, costs have been pushed in the same direction. In England, in 2019, the average student left University with student loan debts of £35,950. In Scotland, where tuition is free for UK citizens that are residents in Scotland, the number was £13,800. Wales and Northern Ireland had similar amounts, £23,500 and £22,920 respectively. Debt repayments eat into earnings, leaving less money available to save for a home, or importantly, retirement. If incomes were growing at the same pace as the cost of a higher education, the problem would be less severe. They’re not. According to the Institute for Fiscal Studies, in their report ’10 years on – have we recovered from the financial crisis?’, “The growth in real earnings of employees has differed for different groups over the last 10 years. For those in the 20s or 30s, median earnings in 2017 were 5% and 7% lower than in 2008 respectively.” In contrast, in England, Wales and Northern Ireland, the cap on student fees has moved from £3000 in 2007, to £9,250 in 2018 (£9,000 in Wales), largely driven by less government funding and increasing operating costs for universities.
The labour market will continue to demand a higher skilled workforce as we move towards ‘Industry 4.0’. This shift will see more high skilled jobs created, while lower skilled jobs are replaced by automation. So how can the burden of student debt be decreased for future generations? It’s unlikely that the government will increase their funding for higher education when they’ve got COVID-19 related expenses to take care of. I believe Universities need to take a look at their business model and make significant changes. We’ve seen in recent weeks how Universities across the globe have had to pivot quickly, providing online lectures and other forms of distance learning. Why can’t they scale their business by providing more online offerings? Instead of paying one lecturer to teach 200 students per year, that lecturer could be reaching 20,000 students. How many subjects really require education on site? Medicine, engineering, etc. all require some form of laboratory work, but many others don’t. The capital expenses related to infrastructure improvements are significant, with online offerings, these are significantly reduced. I also question whether degrees really need to last as long as they do? The relevancy of much of the content I studied has been worthless. In that respect, I could’ve entered the workforce at a younger age, giving me additional time to save for retirement. If Universities fail to pivot, their business will be upended by those that do. The internet has killed a number of big brands who failed to evolve, including Blockbuster and Toys R Us. Universities may well be next.
It’s become more expensive to get on the housing market.
The boomer generation has seen the value of their homes increase significantly, building up more and more equity in the process. An article in the Financial Times stated that, “Average house prices rose 152% in the 20 years to 2015-16, while net family income for 25-34-year-olds only grew by 22%”. Due to the growing disparity between house prices and household incomes, millennials are getting their first property at an older age compared with prior generations. In the same article in the Financial Times, it stated that, “At the age of 27, people born in the late 1980s had a home ownership rate of 25%, compared with 33% for people born just five years earlier and 43% for those born 10 years earlier. One factor that has made housing more affordable for millennials are interest rates. Since the great recession, interest rates have remained severely depressed and are now at their lowest ever level in the UK. This helps with ongoing mortgage repayments but doesn’t help millennials build enough cash for a deposit.
The government stepped in with the Help to Buy scheme in 2013, where first time buyers can purchase a property with just a 5% deposit, with the government providing 20% of the purchase price interest free for five years, making a total deposit of 25%. I remain sceptical of this scheme due to the reliance it places on growing house prices. An article in the Financial Times Advisor states that, “New-build properties typically cost about 15-20% more than the equivalent lived-in home so buyers who want to sell their property soon after purchase could be in negative equity as this premium drops away.” If you’ve got 5% equity at the point of purchase, and this premium of 15-20% drops away, you’re in trouble if you can no longer afford mortgage payments and need to sell. Homeowners are benefiting from low interest rates, but if those rates were to rise by 300 or 400 basis points, this scheme may leave homeowners and the government with distressed balance sheets. I believe the Help to Buy scheme should be restricted to those that require it financially, as opposed to being open to anyone. This would dampen demand, and restrain the price increases that we’ve seen, making housing more affordable to those who really need it.
Millennials aren’t saving early enough.
To maximise your retirement savings, you need to start contributing early, ensuring you leverage the power of compound interest. It’s believed that Einstein said compound interest is the ‘eighth wonder of the world’. So, what is compound interest? Compound interest can be thought of as interest on interest and will make a sum grow at a faster rate than simple interest, which is calculated only on the principal amount. Let’s see how compound interest works with an example. Below, Fiona, David and Rachael achieve the same 7% annual return on their retirement funds. The only difference being how often and when they save:
Fiona begins investing at 18, contributing £5,000 per year. She stops investing at age 28. In ten years of investing, she has contributed £50,000.
David contributes the same amount per year but doesn’t begin contributing until he reaches age 28. He continues investing the same amount annually until he reaches retirement age at 58. He has invested £150,000 over this period.
Rachael invests £5,000 per year from age 18 until retirement at age 58. She has invested a total of £200,000.
Here are the pension pots of each individual at age 58:
Fiona has £602,070, David has £540,741 and Rachael has a whopping £1,142,811.
Rachael only invested £50,000 more than David, but at retirement, she has £600,000 more. That’s the power of compounding. That’s the power of being invested for longer.
It’s clear that it’s imperative to start saving early. This sadly isn’t happening. A YouGov report in 2017 titled ‘Bridging the Young Adults Pension Gap’ states that “44% of 18-34-year-olds say they have no pension provision whatsoever”. So why is this happening? In a BNY Mellon report titled ‘Generation Lost: Engaging Millennials with retirement savings’, it states that “90% of millennial respondent to our survey estimate the amount they will need in retirement by taking a blind or educated guess.” This suggests that millennials are simply unaware of how much they’ll really need in retirement and are therefore not contributing what they need to. I also believe there is a link back to the combination of stagnating incomes, rising student loan debts and rising home prices. If someone is burdened with student loans, they have less to invest. If someone wants to save to buy a house, they need to put money aside to purchase that house.
Fortunately, the UK government rolled out auto enrolment in 2008, whereby employees have to opt out of a pension as opposed to opting in to one. I fear that the situation would’ve been much worse had this not been introduced. There are gaps though. Self-employed or contract workers are not covered by this scheme. Why is this important? There is a trend in the labour market towards something known as the ‘gig economy’. This includes jobs provided by household names such as Uber and Deliveroo. These workers are self-employed and not entitled to the same benefits as those in full time employment. The Guardian reported that the gig economy in Britain doubled in 2019, and now accounts for 4.7 million workers. Although these jobs provide flexibility, employees need to be aware of the shortfalls, and I feel many aren’t.
Millennials face another headwind when it comes to retirement. They’ll need more than previous generations because they’re likely to live longer, they’re unlikely to be part of a defined benefit pension plan and it’s becoming ever more likely that state pensions will cease to exist. So, what can millennials do to change the outcome of their retirement savings?
Millennials, you must start by calculating how much money you’ll need in retirement. If you don’t know where you’re trying to get to, the chances of you getting there are slim. Once this number is ironed out, you should utilise a pension calculator to calculate how much you’ll have in your pension pot based on current monthly contributions. The pension calculator will then show you if a shortfall exists. If a shortfall exists, you either need to accept a lower standard of living in retirement or increase your monthly savings until you hit your target. If this interests you, here’s a link to a Standard Life web page that has all the pension calculators you’ll need to perform these calculations. https://www.standardlife.co.uk/c1/pensions-and-retirement/saving-for-retirement.page If you don’t want to lower your standard of living and believe you can’t save more, the only practical advice I can share is that you must upskill and make yourself more valuable to the job market. This way, you’ll increase your lifetime earnings and have more capacity to save. You should also ensure that your pension is invested in assets that are aligned with your pension goals, i.e. higher risk assets will provide better long-term results. See ‘Tip 2 – Be adventurous’ in this article from Hargreaves Lansdown, https://www.hl.co.uk/news/articles/early-careers-retirement-saving-in-your-20s.
Schools didn’t provide a financial education.
Financial education is a real problem for millennials, and the generations that have gone before us. Financial education is now compulsory in UK schools, but for millennials and those before us, we missed out. We need to educate ourselves and take responsibility for our own financial future. Unfortunately, I know the majority of people won’t, and this will hurt them going forward. They will continue to have financial worries, will need to work later in life, will experience a lower standard of living in retirement and likely still be paying off their mortgage in their 70s. To really increase financial education, millennials need help from financial institutions and employers.
Financial institutions need to step in and educate our generation. They would benefit too. With more financially educated individuals, these institutions will likely see a reduction in defaults, as those individuals take better care of their personal finances. I believe they’d also see increased revenues as customers may be more willing to take other products, such as life insurance and income protection insurance. Most people are unwilling to take these products because they don’t understand them. Furthermore, customer retention would see an uptick as customers would trust the business that’s helping them create a more secure financial future.
Employers can also help by educating their workforce. I believe the cost would be minimal on the grand scheme of things, but they may benefit from an increased level of productivity. Employees would be more likely to have their finances in order, meaning they are less likely to be distracted during working hours. It may also increase loyalty, as the employer has demonstrated care for their employees.
Our financial future is far from certain, with many factors contributing towards the uncertainty, from a rise in nationalism to the introduction of ‘Industry 4.0’, but as the old saying goes, “control what you can control”. We must increase our financial education to ensure we’re doing the right things financially, including taking advantage of tax-advantaged savings, saving early, minimising unnecessary expenses and investing in high-return assets. We must ensure we become as valuable as we can to the labour market by educating ourselves, gaining skills and acquiring knowledge.