Value Investing Redefined: The Surprising Ways Millennials Are Changing Investing

It’s been a rough week for investors. The first four trading days of 2016 were the worst ever start to a new year for the U.S. markets. Growing concerns over China, the price of oil and increasing tension between Iran and Saudi Arabia contributed to the market decline.

For millennials, young adults born between 1981 and 1997, it’s likely more evidence of the precarious nature of investing. Young investors appear less willing to invest in the market than older cohorts. They are holding nearly double the amount of cash that older investors are, with an average portfolio allocation of 52 percent for those under the age of 36, and 23 percent for all other investors, according to UBS Investor Watch.

But despite the recent market turmoil, economic history confirms that stocks generate greater returns than safer options such as bonds and cash. Even wage growth can’t compete with investment returns.

“Millennials have to remember that their investing time horizon is an advantage," said 28-year-old Tom Staudt, head of product development at Ark Invest. "They have the luxury of ignoring some of the short-term volatility that perhaps older generations don’t have," he added.

They may not be investing enough, but there does seem to be one investment option that has captured the attention of younger investors: exchange traded funds (ETFs). After cash, ETFs are the most common investment held by millennials, comprising 41 percent of their portfolios, compared to 21 percent among all investors, according to a recent Schwab study.

Millennials may be early adopters, but ETFs are gaining momentum across the board. Last year, Americans poured $238 billion into ETFs, more than they invested in index funds, managed mutual funds and hedge funds combined, according to Bloomberg. The total amount invested in ETFs now stands at $2.1 trillion, and that number is likely to grow. Research shows over 60 percent of 25- to 35-year-olds plan to invest more in ETFs in 2016. They’ve certainly got the cash to do it.

ETFs Trump Mutual Funds

ETFs, like mutual funds, represent a basket of stocks or bonds grouped together by a common category, such as large U.S. companies. But unlike mutual funds, which trade only once per day and reveal the details of their investments four times a year, ETFs trade constantly while the market is open. At any given point, an investor knows exactly what is happening, good or bad. There isn’t a mysterious fund manager pulling strings behind the curtain. For that reason, they also tend to be less expensive than mutual funds.

“From a millennial’s point of view, their appreciation for ETFs and passive investing comes down to three things: trust, cost and transparency,” said 21-year-old Jessica Rabe, an assistant vice president and research associate at Convergex Group.

“ETFs are far more in line with the millennial lifestyle and mindset. They’re used to getting their news in real time on Twitter. That same mentality carries over into how they view the rest of the world, financial markets included,” Staudt said.

The rise in popularity of ETF portfolios by robo-advisers like Wealthfront and Betterment illustrates this trend, but it doesn't show the whole picture. Millennials may trust robo-advisers, automated computer algorithms that manage investments, over the advice of a well-paid financial adviser at a large bank, but in many ways robo-advisers are just a new version of an old financial product.

The traditional approach to ETFs may eventually be too vanilla for millennials' taste. “It’s not as exciting. There’s no emotional response to the S&P 500 index. There’s no story there, you can’t talk about it with your friends,” Staudt said.

Baiju Prafulkumar Bhatt and Vladimir Tenev, co-founders of the free brokerage app Robinhood, are betting that millennials want more than an auto-generated ETF portfolio. The two friends started Robinhood in 2013, when Bhatt was 28 years old and Tenev was 26 years old. “I think it’s a part of each person’s desire for individuality not to have a one size fits all,” said Bhatt.

Investors who use robo-advisers tend to skew slightly older than millennials, with the median age ranging from mid- to late-30s. By contrast, the median age of account holders on Robinhood’s self-directed trading platform is 28 years old. Since launching last year, Robinhood has amassed more users than all of the robo-advisers combined, according to Bhatt. Millennials may be skittish about investing, and their account balances may be small, but both are likely to change overtime. Gaining their loyalty is important.

For young people to get excited about investing, words like market capitalization, tax efficiency and even retirement are not going to cut it. They want to interact with the products and ideas that surround them in their everyday lives.

Value Investing For A New Generation

Indeed, the trend to watch, according to Ben Johnson, director of Global ETF Research at Morningstar, is values-based investing, with a focus on environmental, social and governance (ESG) themes. “If Millennials and ETFs are BFFs, millennials and ESG ETFs are going to be the best of besties,” he said.

Financial professionals have largely dismissed socially responsible investing (SRI) options as niche products, and some experts worry that naive investors are trading returns for lofty ideals. But Johnson says that isn’t true.

“It’s a persistent myth that by focusing on your values or screening companies based on certain criteria you’re somehow sacrificing investment outcome,” he said. “Others would argue it’s actually slightly favorable from an investment return point of view.”

Regardless of skeptics, thematic investing is likely to continue to expand, driven largely by millennials looking for investments that fit their worldview and priorities. To attract younger clients, financial companies will have to learn to think like a millennial.

According to Staudt, that means building funds around an idea, concept or story, rather than an index, sector or geography. “Whether that story is curing cancer, or 3-D printing or the next generation of the web, they have their own belief set on what's going to transform their lives, and they're willing to put their money where their mouth is,” said Staudt.

In this vein, Ark Invest offers actively managed ETFs focused on next generation themes that resonate with millennials, like industrial innovation and genomic revolution. In an industry where the average employee is about 50 years old, Ark's analysts stand out. Approximately two-thirds of the staff is under the age of 35.

Change in the financial services industry isn't likely to happen quickly, but that doesn’t mean young investors should sit back and wait.

“Just get started,” said Bhatt. “It’s not nearly as scary as the pundits will lead you to believe that it is. It’s fairly enjoyable as an experience.”