Millennials’ finances could face a new stress: slower growth of the U.S. economy. Compared with their parents, today’s younger workers might need to save more for retirement.
A number of analysts predict that the continuing pattern of slower growth that has taken hold since the Great Recession could cause stock market returns to fall from 7 percent, the annual average since about 1950, to a possible 5 percent in the decades to come. And that could hurt investors saving for retirement.
The difference of two percentage points in broad stock market returns has big implications for younger adults who are just starting to save for retirement and also for those who’ve been investing for about a decade. An analysis by NerdWallet shows that millennials, who could earn a 5 percent return over the bulk of their investing lifetimes, may be required to save 22 percent of their annual income to make up the gap, up from the recommended 15 percent target.
“The era of supernormal returns is over,” said Martin Small, the head of U.S. iShares for BlackRock.
To help a millennial investor prepare for the future, NerdWallet analyzed the saving needs of a 25-year-old earning $40,000, the median salary for ages 25-29, according to the U.S. Census Bureau.
Based on the 7 percent average in stock market returns each year since 1950, a 25-year-old earning $40,000 can meet a common retirement goal of replacing 80 percent of his or her income by age 67 by saving 13 percent of annual income.
But if average annual stock market returns fall to 5 percent, a 25-year-old will have to set aside 22 percent of annual income to save the same amount. That’s an increase of $3,400 this year.
In addition to saving more income, lower investment returns mean millennials may need to start contributing earlier to a retirement savings account than their parents did, or plan for longer careers. Use a retirement calculator to assess progress toward retirement goals and identify potential gaps. Take advantage of tax benefits and employer matches. Estimates show a quarter of employees aren’t contributing enough to get the full 401(k) match. Those who don’t have a 401(k) can get a tax deduction by making contributions to a traditional IRA.
Don’t stash your retirement money in a savings account. Focus first on earning your employer’s 401(k) match and setting aside at least $500 in case you need quick cash. Then, consider opening a Roth IRA account.
Jonathan Todd is a data analyst at NerdWallet, a personal finance website.