Millennial Investors, Say Goodbye to TINA

2023 Wrapped: Resilient Yet Sober, Higher for Longer

Headed into the holiday season of 2023, investors are thankful for plenty.

U.S. stocks have rebounded from 2022’s inflation-induced spiral. The S&P 500 Index has climbed over 13 percent[1] over the 12 months leading up to November 20th, 2023. Over the same time period, the MSCI EAFE Index (net returns) is up roughly 8 percent[2]. Resilient yet sober.

Performance might not inspire the same letter home on the bond side, but investors are grateful for something even more important: higher yields. Fixed income has survived a controlled burn that’s restored a healthier ecosystem for long-term investors.

Now, with inflation continuing to cool, investors gaze toward the horizon for what’s next in a world with higher rates. Despite finding steadier footing in 2023, it’s apparent that navigating the next path requires a different roadmap.

It’s Not Goodbye; It’s See You (Much) Later

Signs point to U.S. interest rates remaining higher for longer. At the November 1st  FOMC meeting, the Federal Reserve voted to hold rates steady between 5.25 to 5.50 percent[3] for the second time in a row.

The Fed appears content with how the economy is humming along, but there’s very little case for rate cuts yet. In its most recent FOMC meeting statement, the Fed remains “highly attentive to inflation risks.” (In fact, the memo mentions the word “inflation” nine times in just 300 words of text, but who’s counting?)

With year-over-year inflation in the U.S. still clocking in at 3.2 percent[4] as of October 2023, above the 2 percent target, it’s unlikely the Fed will reverse course soon. Once it eventually does pivot, the process will be gradual. Even swift cuts in 50 basis point increments would still take more than ten consecutive meetings to return rates to zero. For perspective, there are only eight Fed meetings per year.

The new rate regime has millennials realizing they’re not in Kansas anymore. Their low-interest-rate roadmap might be outdated, but they do already have some of the requisite skills to find their way.

“Some lessons have to be experienced before they can be understood.”

This quote is from Michael Batnick, otherwise known as the Intelligent Investor[5], and is featured in Morgan Housel’s 2020 book, The Psychology of Money. In the book, Housel points to the phenomenon that people’s lifetime investment decisions are heavily anchored to their own experiences, especially those from early adulthood.

In other words, over our lifetimes, investors tend to prefer the asset classes in favor in our 20s and 30s. This might look like entire generations who come of age during stock bull markets collectively overweighting equities throughout their lives.

The defining investment theme over the past 15 years was TINA. Fueled by an extremely supportive Fed, millennials began their careers at the start of an equity ‘super cycle’ that lasted from 2009 to 2020. With interest rates so low, there was no alternative to stocks.

One would’ve been hard-pressed to make a case for bonds in young investors’ portfolios during this time. Who needed them when they came with low yields and substantial duration risk? Plus, younger investors often have a high enough risk tolerance to invest primarily (if not totally) in stocks.

Now in 2023, with millennials ranging from ages 27 to 42, they’re reluctantly taking their first hard look at adding bonds into the mix.

Sideline Cash: A TINA Bias in Action

Millennials are famed industry-killers, but they won’t be adding money market funds to their list of casualties.

Attracted by higher short-term yields, investors are piling into cash-like investments. The Investment Company Institute reported that over $5.73 trillion[6] was held in money market funds as of November 15th, 2023. This is up 44 percent from the $3.98 trillion in November of 2019[7].

Moreover, according to the 2023 Betterment Retail Investor Survey[8] of 1,200 investors across four generations (gen z, millennials, gen x, and boomers), millennials are the biggest fans of cash. 83 percent surveyed said they plan to hold steady or increase their cash holdings.

It looks like millennials are allocating their first conservative portfolio slices to cash-like investments, not bonds. This may be short-sighted.

In fairness, many money market funds yield over 5 percent in November 2023. This makes them an attractive yield play, but it’s also an ephemeral one. Investors concentrated in short-dated securities will only benefit from higher yields while short-term rates remain elevated. In this sense, piling into money market funds is a making bet that the Fed will not cut rates.

With rates at today’s levels, holding cash-like investments in the place of bonds comes with a major opportunity cost, as long-term investors could be missing out on locking in higher yields by increasing duration. Duration, or interest rate risk, inflicted pain on the bond market as the Fed increased rates. Yet, it’s what contributes to potential outperformance of longer-dated bonds when interest rates eventually fall.

It’s impossible to know if interest rates will rise, fall, or remain the same from here. Managing this uncertainty is where millennials’ ability to stay the course, a lesson learned during the TINA years, may have already created a built-in superpower.

Fixed Income Barbells: Bonds Without Bets

Learning how to stay the course with an all-equity portfolio is like learning to drive a car with a manual transmission on your learner’s permit, only to take your driver’s exam with an automatic. In this sense, millennial investors have learned to resist temptation to make short-term bets on one of the most challenging asset classes possible.

Now, faced with the early stages of de-risking their portfolios and adding bonds, staying the course should feel like investing on easy-mode. So, how can investors balance higher short-term rates today with the benefits of duration risk and return that come with longer-dated bonds?

An updated roadmap for investing in a higher-for-longer world includes a fixed income barbell strategy. Many investors are familiar with a laddered bond approach. A fixed income barbell takes out the middle rungs of the ladder, leaving just the shortest and longest rungs.

On the “short” end of a barbell, investors might insert floating rate treasuries. This provides access to elevated income levels with trace duration and credit risk.

To populate the “long” end of the barbell, consider adding core bonds with durations similar to that of the Bloomberg U.S. Aggregate Bond Index. Assuming some duration exposure positions the portfolio to benefit should interest rates fall over time.

To build your own, here’s a fixed income barbell calculator that quantifies yield and duration trade-offs using a two-ticker solution.

Until this point, there hasn’t been a compelling case for millennial investors to dip their toes into bonds. Higher rates have now revitalized the traditional roles bonds play in portfolios, just in time for this generation to dip their toes into the fixed income waters.

With a balanced portfolio and updated roadmap, good things can happen when preparation meets opportunity. Whether they realize it or not, the millennials are prepared with the skills they need to succeed in this next era. Opportunity awaits when they say ‘goodbye’ to TINA

Important Information:

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There are risks associated with investing, including possible loss of principal.  Securities with floating rates can be less sensitive to interest rate changes than securities with fixed interest rates, but may decline in value. Fixed income securities will normally decline in value as interest rates rise. The value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. Investing in mortgage- and asset-backed securities involves interest rate, credit, valuation, extension and liquidity risks and the risk that payments on the underlying assets are delayed, prepaid, subordinated or defaulted on. Due to the investment strategy of this Fund it may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile

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[1] S&P 500 Index TR USD, 11/21/2022 to 11/22/2023, https://www.investing.com/indices/us-spx-500

[2] MSCI EAFE Index NR USD, 11/21/2022 to 11/22/2023, https://www.investing.com/indices/msci-eafe-net

[3] https://www.federalreserve.gov/monetarypolicy/files/monetary20231101a1.pdf

[4] https://www.bls.gov/news.release/cpi.nr0.htm

[5] https://theirrelevantinvestor.com/

[6] https://www.ici.org/research/stats/mmf

[7] https://www.sec.gov/files/mmf-statistics-2023-07.pdf

[8] https://www.betterment.com/hubfs/PDFs/b4c/2023%20Betterment%20Retail%20Investor%20Survey.pdf?hsCtaTracking=69d9f79e-8a13-4b43-bcd4-a0a1f6f2db5b%7Cb0206445-ff41-472c-b584-7c3175a47f93