It’s Time for Your Annual (Financial) Checkup

BrokeI had my annual physical yesterday morning, and the doctor says I’ll be around for a while, so that’s a good thing. But on the way back from his office, I listened to a segment on NPR, and I know that my blood pressure rose as a result.

The Morning Edition segment featured a Bankrate.com survey and analysis of the under-30 crowd relative to savings and investment. The essence of the survey was that the data revealed that, as young people in their twenties begin to have some money to allocate toward savings and investment, they are extremely risk-averse. Specifically, the analysis revealed that 39% of those surveyed say that cash is their preferred way to invest money they don’t need for at least 10 years. That is three times the number of young adults in the same survey who picked the stock market. The radio segment regarding the survey also noted that this could be due in part to the fact that many of those surveyed had developed these discretionary funds in the midst of the recent recession and, as a result, were unwilling to see a similar future downturn destroy their savings.

“The preference for cash and aversion to the stock market among young adults is very troubling considering this age group has the biggest retirement savings burden. They won’t get there without being willing to assume a little short-term price risk in their long-term money,” said Greg McBride, CFA, Bankrate.com chief financial analyst.

I counsel college students every month regarding the importance of getting started early with investing. I generally first have them face the man in the mirror by completing a personal financial statement. That is always a good solid slap of reality. And my first caveat, of course, is that for any type of investment decision I direct them to consult only with licensed financial professionals, and we discuss the process for selecting an advisor. We then discuss the basic concept of the time value of money and why it is so important to get started early and take a long-term approach. That is followed by a discussion of risk tolerance, and we look at the current economic climate and historical data, reviewing examples of rates of return for various categories of investment, from bank savings to the equity markets. And we talk about inflation, the negative impact it has, and the need for our investments to outpace it.

As a financial social worker, I have similar conversations with others, but my main focus is almost exclusively college students in undergraduate and graduate degree programs. So I was especially disturbed to hear this morning’s radio segment and the implications it has for young people, in general. If in fact twenty-somethings are placing their funds allocated for savings in commercial banks, they will soon find that the math just doesn’t add up. The interesting thing, of course, is that so many of these newbie investors have failed to consider the real implications of what may sound like a safe and prudent decision, only to later realize it is anything but.

After hearing the story on the radio, I did some quick research via Bankrate.com to see what the three largest banks in our area are paying for savings accounts. The answer: .01%, .02% and .03%. No, you’re reading that right – one hundredth of one percent, and so on. But hold on, bank fans, we’re done yet. For the three banks surveyed, the opening balance requirements were very modest, but the minimum balance to avoid fees was not – specifically $2,500 to $5,000. Monthly account maintenance fees were $10 for one bank, and $12 and $15 for the other two.

We all know that investing in the stock market is risky and, once again, I always refer students to licensed professional advisors, not just educators like me. But I also encourage students to think through various investment scenarios by conducting research, and creating “what if?” scenarios.

Hmmm… let’s see. What if one year ago, a student invested $1,000 in an index fund that tracks the S&P 500? The S&P has seen a return of 24.61% over the past 12 months, through June 2014 – pretty respectable, and much higher than the historical long-term average of 11.64%. So that $1,000 a year ago would have shown a balance of (roughly) $1,246 as of the end of June 2014.

That same amount placed in a Wells Fargo savings account (the highest interest rate and lowest monthly fee of the three banks I checked locally, and assuming no additional deposits are made) would have gained 30 cents in interest over the same period, but would have incurred $120 in fees ($10 per month), leaving a balance of $880.30. These numbers are just rough approximations, since technically the interest earned would be slightly less, as fees are deducted from the account each month, but close enough for this example. This represents a loss of 12% over the same one-year period. Hmmm… what’s wrong with that picture?

To be fair, we could claim that the $1,000 invested in the S&P index fund was technically 100% at risk, provided we can imagine the possibility that all stocks in the index could have lost 100% of their value over the past 12 months. But more logically, one could certainly argue it is possible that the index fund could have dropped by some significant percentage, and that percentage could be more or less than a 12% loss due to fees or a 24.61% gain due to market improvement.

The difference, of course, is that if we knew we would not make any additional deposits that could remove the monthly bank fee, we know for a fact how much value our account will lose in 12 months by putting our money in the bank, while the stock market offers an opportunity for either reward or failure, based on the performance of the S&P’s 500 companies. And while there are absolutely no guarantees regarding any investment in equities, the returns over the long haul have been relatively consistent.

So, college graduates and first-time investors, should you bet on guaranteed failure, or the possibility that our slow economic rebound could result in a substantial gain? What would you do?

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