Think of the Children

Jonathan Clements

I FEAR I’M GROWING wealthy at my children’s expense. My investing life began in the late 1980s. Yes, there have been stock market bumps since then, notably the 2000-02 and 2007-09 market crashes, and even a minor hiccup over the past week. But if you look at the broad trend, it’s been three decades of rising stock market valuations.

From year-end 1987 to year-end 2017, the S&P 500’s price-earnings multiple climbed from 13.8 to 24.6, its cyclically adjusted price-earnings ratio jumped from 13.4 to 32.3 and its dividend yield declined from 3.7% to 1.8%.

And, no, this isn’t distorted by the start date. Despite the October 1987 crash, 1987 was a winning year for the S&P 500, with stocks gaining 5.3%, including dividends. Indeed, the increase in valuations looks similar if you use 1988 as the start date.

Those rising valuations helped propel the S&P 500 to an 8.3% annual share-price gain over the past 30 years. (Add dividends, and the total return was 10.7% a year.) That 8.3% annual share-price gain ran far ahead of economic fundamentals. Over the 30 years, the economy’s nominal growth was 4.7% a year and earnings per share climbed at 6.3%, while inflation notched 2.6%.

If share prices had merely tracked earnings growth, annual returns would have been two percentage points lower, and if they’d tracked nominal economic growth, the results would have been three-and-a-half points lower. Think of it this way: My generation has contributed to an economy that’s done okay, but not great—and yet we’ve pocketed stock-market rewards worthy of economic superstars.

There are all kinds of possible explanations for the market’s heady performance. Our economic fears have subsided and our appetite for investment risk is far greater, thanks to the long post-World War II period of prosperity. We have an abundance of capital sloshing around the globe, chasing limited investment opportunities. Interest rates are far lower today than 30 years ago, making bonds and cash investments less attractive. Sluggish wage growth and lower corporate tax rates have fattened company profit margins. Shrinking investment costs have made the financial markets more appealing.

Whatever the reasons for the market’s spectacular performance, I’m now sitting with a portfolio that will easily pay for retirement. I reaped the reward of the long rise in valuations—and I even got a couple of nice market crashes that allowed me to buy stocks at bargain prices. I’m startled by my good fortune, but also aware that it could slip away, so I have been gradually easing out of stocks and purchasing more bonds, especially inflation-indexed Treasury bonds. I’ve won the game, so I see less reason to keep playing.

Meanwhile, my adult children are buying. The stocks that I’m selling to pay for my retirement, and which strike me as overpriced, are the ones they’re purchasing to pay for their retirement.

Over the next three or four decades, my children will likely make decent money in stocks. But given today’s starting valuations, I suspect their returns will be far lower than mine.

But what choice do they, and others in their 20s and 30s, have? Stocks may generate lackluster results, but they should perform better than bonds and other more conservative investments. My advice to my children: Save as much as you can, allocate 40% and perhaps even 50% of your stock portfolio to foreign shares, with their more reasonable valuations—and hope for tumbling markets, so you can buy at much lower price-earnings multiples.

Think of the Children (Part II)

ALMOST EVERYBODY says they’re middle class, so the term has lost almost all meaning. What’s the alternative? Instead of middle class, I think of myself as part of the investing class—with “investing” used in the broadest sense. I want to use the money I’ve saved not only to maintain my financial position, but also to give my children and stepchildren a leg up and (whenever they show up) their children as well.

To be able to do so is a privilege. Many parents barely have the wherewithal to support themselves, let alone help their children.

But to do so is also increasingly difficult. For earlier generations, simply getting the kids into college was the key to continued family prosperity. Now, not only is a bachelor’s degree typically a costly endeavor, but often it also isn’t enough. To stand out in the work world and thrive financially, those in their 20s and 30s may need advanced degrees, as well as parental help with other goals. All this raises three key questions:

1. Should you help? If you provide financial assistance to your adult children, there’s a danger you’ll kill their ambition with kindness.

But I suspect that, whether you help or not, the damage is probably already done. Simply growing up in a comfortable household will often squelch children’s financial ambition. Why would they worry about having enough money if they never saw their parents worry?

You could try to instill that financial ambition by, say, deliberately depriving your kids from an early age. But that strikes me as harsh and undesirable. Instead, I would worry about a bigger issue: making sure your children have some ambition, even if it isn’t financial ambition. You don’t want your kids meandering through life and missing out on the great pleasure that comes with working hard at something they’re passionate about.

To avoid that fate, encourage your children to find a purpose that will make their lives fulfilling and make the world a better place. That purpose may not make them rich. But it should enrich their lives.

2. How much help can you afford to give? You won’t be doing anybody any favors—yourself or your children—if you provide substantial assistance to your kids, only to discover later that you don’t have enough for your own retirement.

My recommendation: Give serious thought to how much financial support you can offer and which goals you want to help with, and then have occasional frank conversations with your children. You want to manage their expectations, so they know what help they will receive and where you’ll draw the line.

Try to have that first serious money conversation when your children are high school freshmen. You should talk to them about how much help you can offer with college costs, so they know whether they can aspire to ritzy private colleges or should look instead at state universities and community colleges.

If they’ll need to take on student loans, that should be part of the conversation. Talk to those in their 20s and 30s with education debt, and many will readily admit they didn’t understand what they were getting into. As a responsible parent, you should discuss likely career earnings and hence how much your children can reasonably borrow.

Ideally, your children will opt for colleges that leave them with little or no debt. There’s mounting evidence that student loans put young adults at a lifelong financial disadvantage, with many struggling to buy homes and save for retirement.

3. How can you leverage your dollars? If you’re like me—part of the investing class but still financially constrained—you should think not only about how much help you can provide, but also how best to use both those dollars and your parental influence to get your children on the right track financially.

To that end, consider seeding your adult children’s financial future. That might mean helping them set up accounts for different goals, such as a Roth IRA for retirement, high-yield savings accounts for emergency money and for their future house down payment, and 529s for the grandchildren.

You could provide the initial investment for these accounts and then encourage your children to contribute regularly thereafter. By doing so, you emphasize the goals you think they should focus on—and you get a chance to pass on your financial wisdom, by picking the right accounts and selecting appropriate investments.

You might also encourage your children to think longer-term, so they fund retirement accounts and buy stocks. But how? You could reassure them that you stand ready to help in the short-term if, say, they lose their job or get hit with surprisingly large medical bills. With your backing, they might be comfortable raising the deductibles on their various insurance policies and keeping a somewhat smaller emergency fund. That, in turn, will give them additional money to sock away toward longer-term goals.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

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