3 August 2023

The wealth gap between young and old is growing and the super storm of property prices, superannuation and favourable tax policy that has benefited Baby Boomers so immensely is unlikely to ever be seen again.

Since Millennials and Gen X are facing different financial challenges that set them apart from previous generations, it's unsurprising that many are choosing to manage their own financial affairs. This do-it-yourself (DIY) approach to wealth management may initially seem like a cost-effective solution, but it could also come with challenges and potential pitfalls that should be considered.

Before we jump into exploring the factors behind these unique set of financial challenges and the rise of DIY financial management among Millennials and Gen X, let’s looks how retirement and financial planning are perceived by younger generations.

Attitude towards retirement and the perception of financial advice

There are over 5 million Gen X'ers across Australia, and most do not have a proper plan in place for retirement. Research from our report, The Cost of Doing Nothing in Retirement, suggests that most Aussies have adopted the mindset that retirement is something they’ll deal with later in life.

Despite more than 80% of Australians believing they could benefit from financial advice in retirement, only 30% have sought advice. This is concerning and suggests Australians are putting off planning for retirement, hoping their super will be sufficient once they get there. But what’s more concerning is that 89% of Millennials and 83% of Gen X believe obtaining professional financial advice could benefit them in retirement – so why aren’t they?

When we dug a bit deeper to find out what was stopping Australians from accessing financial advice to help them plan for retirement, the results showed that cost, value and procrastination were the primary drivers preventing people from accessing financial advice. Across genders, the cost of advice was cited as the number one barrier preventing men (32%) and women (34%) from accessing financial advice. Not earning enough to make it worthwhile was second (28% men, 32% women) and 27% of men and 21% of women said they looked after their own financial affairs.

When you combine the misconception about cost and value of financial advice with the lack of urgency to plan for retirement and an array of financial challenges, the outlook for Millennials and Gen X seems problematic. So, what are some of the factors driving these financial challenges?

Factors contributing to the financial challenges of Millennials and Gen X

• Delayed entry into the workforce due to higher education. Higher education has become increasingly important in the modern job market, leading to a higher proportion of young individuals pursuing tertiary education. However, this pursuit results in delayed entry into the workforce. According to the Australian Bureau of Statistics, in 2020, the median age at which Australians complete full-time education was 22 years for men and 23 years for women. This delay in starting their careers affects millennials and Gen X by potentially limiting the years they can accumulate wealth and contribute to their superannuation.

• Part-time work and underemployment. Many millennials and Gen X individuals find themselves in part-time employment or facing underemployment. According to the Reserve Bank of Australia, around 32% of employed people aged 15 to 24 worked part-time in 2020. This prevalence of part-time work, often associated with lower wages and fewer employment benefits, hampers their ability to generate substantial income and build savings or investments.

• Limited homeownership opportunities. Rising property prices and stricter lending criteria have created significant barriers to homeownership for millennials and Gen X. The difficulty in accessing the housing market means that young individuals miss out on the benefits of homeownership, such as long-term wealth accumulation through property appreciation and the stability of having a valuable asset.

• Wage stagnation and increased debt burden. According to the Australian Bureau of Statistics, average weekly earnings for full-time employees increased by 3.4% from 2010 to 2022, while the Consumer Price Index rose by approximately 19% over the same period. This wage stagnation makes it harder for young individuals to save, invest, and achieve financial goals. In addition, millennials and Gen X carry higher levels of debt–student loans, credit card debt, and personal loans, significantly impacting their financial stability. According to the Australian Bureau of Statistics, the average household debt grew by 7.3% between 2021 - 2022. This increased debt burden limits their ability to allocate funds towards savings, investments, or homeownership.

The rise of DIY financial management among Millennials and Gen X

There has been a noticeable trend among Millennials and Gen X individuals towards managing their own financial affairs, adopting a do-it-yourself (DIY) approach. According to the National Financial Capability Strategy, six of ten Australians are confident about managing their money.

Some of the reasons fronted by both Millennials and Gen X for handling their own finances include:

• Cost concerns: Seeking professional financial advice comes with fees, and some individuals perceive managing their finances independently as a cost-saving alternative.

• Accessibility of information: The digital age has made financial information readily available. Self-directed investors can research investment strategies, explore market trends, and access financial planning tools, empowering them to make decisions without relying on external advice.

• Autonomy and control: Managing their finances gives them a sense of empowerment and the ability to align their investments and financial strategies with their values and goals.

While self-directed financial management and DIY investing may appear cost-effective in the short term, it's essential to consider the potential long-term consequences of this approach when managing your money or preparing for retirement.

Short-term cost effectiveness vs long-term consequences

Self-directed investing may inadvertently overlook the diversification of investment portfolios. Concentrating investments in a few assets or sectors without the value of financial advice is risky, potentially exposing portfolios to unnecessary risk. In addition, one may fall prey to cognitive biases, such as overconfidence or herd mentality, leading to suboptimal investment decisions.

Also, behavioural challenges, such as emotional decision-making during market volatility, can impact investment outcomes. When self-investing, one may overlook vital aspects of financial planning, such as tax optimisation, estate planning, or retirement strategies, which can heavily impact long-term wealth creation and financial security.

The importance of diversification in investment portfolios

Portfolio diversification is a fundamental principle of investment management that aims to minimise the impact of any single investment on the overall portfolio performance. By diversifying across different asset classes, such as stocks, bonds, real estate, and commodities, investors can reduce the impact of adverse events on their portfolios, providing a cushion against market volatility.

The diversification of investment portfolios also helps to smooth out the fluctuations in portfolio returns. When different assets perform differently over time, the combined performance of the portfolio is less volatile than that of individual investments, leading to more stable and consistent long-term returns.

Hidden costs and risks of lack of portfolio diversification in DIY investing

The risk of self-directed investing is the potential lack of diversification in investment portfolios. Putting a significant portion of the portfolio into a single investment or a few closely related investments can magnify the impact of negative events. If that investment performs poorly, the entire portfolio's performance can suffer.

In addition, without diversification, self-investing may unintentionally have an overweight exposure to certain sectors or industries. The portfolio can be heavily affected if a particular sector experiences downturns or disruptions.

For example, Research Gate's research conducted in 2021 on self-directed investors in the United States found that cognitive and behavioural biases, coupled with a lack of financial literacy, result in undiversified portfolios.

The value of financial advice in portfolio construction and management

Financial advice from a wealth management expert can go beyond investment strategies; a skilled financial adviser offers behavioural coaching and addresses cognitive biases. Behavioural biases can impact investment decisions and overall portfolio performance. Emotional biases, such as fear or overconfidence, can lead to impulsive actions that deviate from rational investment strategies.

A financial adviser may also help investors overcome these biases and make objective decisions based on their long-term goals. They also bring expertise in portfolio construction and risk management, ensuring investment strategies align with an investor's goals and risk tolerance.

They consider an investor’s time horizon, financial objectives, income needs, and risk appetite. By conducting thorough risk assessments and diversifying the portfolio across different asset classes and geographical regions, advisers help mitigate risks and optimise potential returns.

Equity risk-taking, international exposures, and cash holdings

Self-directed investors can potentially display undisciplined equity risk-trading, overview in domestic equities, and excessive cash holdings. A financial adviser helps address these biases by providing objective analysis and recommending appropriate adjustments.

They emphasise the importance of diversification, including exposure to international markets, to reduce concentration risk and capture global growth opportunities. In addition, advisers guide clients in managing cash holdings effectively, ensuring optimal utilisation, and avoiding missed investment opportunities.

Tax-savvy planning and asset allocation research

Effective tax planning is a critical aspect of wealth creation, and financial advisers possess knowledge and expertise in this field. They help clients optimise their investment strategies within the context of taxation regulations, potentially minimising tax liabilities and maximising after-tax returns.

Advisers also conduct extensive research on asset allocation, continuously monitoring market trends and identifying investment opportunities. This research-driven approach allows informed decision-making, ensuring portfolios remain aligned with the evolving financial landscape.

The added value of financial advisers over time

When managing finances and creating long-term wealth, the value of financial advisers becomes increasingly evident. Advisers can provide more than investment strategies, they can offer behavioural coaching, attempt to mitigate losses during volatile market conditions, capitalise on market rallies, and prevent missed opportunities.

Building long-term wealth involves implementing strategies that align with an individual's financial goals, risk tolerance, and time horizon. Financial advisers can develop comprehensive financial plans that consider various factors, such as retirement planning, education funding, and estate planning, to ensure a holistic approach to wealth accumulation and preservation.

The value added by financial advisers

Financial advisers can bring added value to their clients through:

• Behavioural coaching and preventing emotional investment decisions: Self-directed investors often face challenges managing their emotions during market fluctuations. Financial advisers are behavioural coaches, helping clients overcome emotional biases and make rational investment decisions.

• Attempting to mitigate losses during volatile market conditions: Financial advisers' expertise and experience enable them to analyse market trends, assess risks, and make informed decisions. During downturns, advisers can guide on maintaining a well-diversified portfolio, rebalancing investments, and potentially seizing buying opportunities to help mitigate losses and position portfolios for recovery.

• Capitalising on market rallies and avoiding missed opportunities: Advisers can help identifying market trends, recognising potential growth sectors, and capitalising on market rallies. They can monitor investment opportunities and adjust portfolios accordingly to ensure they participate in potential market gains.

Our own financial modelling also shows that despite the costs of professional advice, a financial adviser can potentially save most people time, money, and stress in the long run. For example, using some base assumptions we’ve made about a typical Gen X, our modelling demonstrates that between now and the age of 65, an individual could potentially grow their net assets by approximately 13% or close to $240,000 with financial advice assistance.

*This is a hypothetical example only and for an individual age 49, part of a couple, and have a super balance of $215,000.

If you’re a Millennial, there’s an even bigger potential to increase your net assets through ongoing financial advice. Our example below illustrates that if an individual receives financial advice from the age of 35, they may reach age 65 with approximately $664,000 more than had they not sought any financial advice.

* This is a hypothetical example only and for an individual age 35 with an income of $100,000 per annum and have a super balance of $50,000.

By recognising the added value financial advisers can provide over time, individuals can make informed decisions about seeking professional guidance to help optimise their wealth creation and achieve their financial objectives.

The detrimental effect of missing out on market performance

Market performance can be volatile, with periods of both gains and losses. Historically, some of the best-performing days in the market have occurred close to the worst-performing days. Missing out on these best-performing days can significantly impact investment returns over time.

Illustration of the effect on portfolio value

To illustrate the effect of missing out on market performance, let's consider a hypothetical example. Suppose an investor has a $100,000 portfolio and stays fully invested for ten years. If they capture the full market performance, their portfolio may grow to potentially above $200,000.

However, if the investor tries to time the market and misses just a few of the best-performing days, the impact on portfolio value can be substantial. For example, missing the ten best-performing days during that period could reduce the portfolio value to around $140,000. If they missed the 20 best-performing days, the portfolio value might decrease to approximately $100,000, erasing all potential gains.

Financial advisers help clients navigate market volatility and maintain a disciplined approach to investing by providing guidance, education, and support. Help from financial advisors increases the likelihood of capturing the full potential of market performance over the long term and potentially avoiding the detrimental effects of missed opportunities.

Enjoy the value of financial advice from Findex

With the wealth gap presenting new financial challenges for Millennials and Gen X, one-off financial advice probably isn’t going to be enough as they grow their wealth and begin preparing for retirement. In the face of these challenges, many aged between 35 and 55 may turn towards DIY financial management as a cost-effective solution in the short-term, but this could further hamper their financial gains in the long-term. Instead, Millennials and Gen Xers should take a more proactive look at how long-term financial advice could benefit their financial future – seeing it as an investment rather than a transaction.

Financial advisers serve as behavioural coaches, helping clients overcome biases and make rational decisions. They are crucial in portfolio construction and risk management, addressing equity risk-taking, increasing international exposures, and optimising cash holdings. In addition, advisers provide tax-savvy planning and conduct thorough asset allocation research, ensuring portfolios align with clients' goals.

For help navigating the complex financial landscape, reach out to a wealth management adviser today to help maximise your wealth creation potential.

The views and opinions expressed in this article are those of the author/s and do not necessarily reflect the thought or position of Findex.

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