Why You Can't Get Rich as Quickly as Your Parents

Editor's pick: Originally published June 3.

A golden age, by definition, is a passing phenomenon.

There's a recognizable beginning, at least in retrospect, and an end. Historians generally consider the golden age of Rome, for instance, to have started with the reign of Julius Caesar's nephew Augustus and continued through the death of Marcus Aurelius in the year 180. (Perhaps not exactly as depicted in Ridley Scott's Gladiator, though.)

The golden age of comic books saw the birth of Superman, Wonder Woman and the Flash in the 1930s. Its end can be marked, loosely, by the characters' changing wardrobes: Wonder Woman swapping her star-spangled skirt for shorts and Flash trading his winged metal helmet for a red hood.

Investing has had its halcyon eras, too, and consulting firm McKinsey says the most recent one is over, an assessment that bodes ill for younger investors. A period of above-average returns driven by a sharp drop in interest rates in the U.S., which peaked at 20% in late 1980, and a world population boom that rapidly expanded the workforce marked a period that lasted from 1985 through 2014. 

Returns in those years averaged 7.9% in both the U.S. and Western Europe, according to a McKinsey research team including Richard Dobbs, a London-based director, and Susan Lund, a Washington, D.C.-based partner. That's 140 basis points higher than the 100-year average for the U.S. and 300 basis points higher for Europe.

"Most people who are investors today have been conditioned by the last 30 years," Dobbs said in a telephone interview. They've got a set intuition about how the last 30 years worked and the reality is, as we look at this picture going forward, it's going to be much, much tougher."

The bottom line? To achieve the same wealth at retirement as their parents, Millennials will have to work seven years longer or double the percentage of income they save, McKinsey found. But there will be challenges beyond the household level: Pension funds and university endowments will face growing funding gaps, as bond investor Bill Gross has pointed out repeatedly.

Source: McKinsey

Gross, a portfolio manager at Janus Capital, dates the investing boom to 1976, rather than 1985, but he reaches the same conclusion as McKinsey.

"This 40-year period of time has been quite remarkable -- a grey if not black swan event that cannot be repeated," he wrote in a June investing outlook. "You have a better chance of observing another era like the previous 40-year one on the planet Mars than you do here on good old Earth."

The percentage changes may look small at first glance, but the real-dollar impact is tremendous, Lund explained during an interview. 

"You look at the U.S. household sector, and it holds, either through 401(k)s or directly, about $25 trillion of equities and bonds," she said. If returns drop by 2 percentage points, that's "worth $500 billion less in investment earnings, so that's huge."

The shift would likely double the existing funding gap in public pensions over a 20-year period, Lund said, "a very bad news story for household savers, pension funds and investors."

Because many investors today have lived their entire professional lives during the boom, they expect future returns at the same level, McKinsey noted. But the underpinnings of those returns -- falling inflation, declining interest rates and strong economic and corporate profit growth -- are no longer in place.

Interest rates in the U.S. and western Europe, for instance, are at historic lows, restricting interest income at companies from Bank of America  (BAC) to JPMorgan Chase  (JPM) and Morgan Stanley (MS) . The European Central Bank has gone so far as to adopt negative interest rates in an attempt to bolster the region's economy, while the Federal Reserve cut U.S. interest rates to almost zero during the 2008 financial crisis and left them unchanged for seven years.

The Fed now projects only two hikes this year, instead of the four it signaled after a 25 basis-point increase in December.

That leaves little room for interest-rate declines like those of the 1980s, even if the Fed raises interest rates as soon as this month -- as some monetary policy committee members suggested it might before particularly weak job growth in May -- and follows up with regular increases for the foreseeable future.

To illustrate, if the central bank had followed through on the four 25 basis-point increases originally forecast for this year and maintained the same pace each year afterward, reaching the peak interest rates of the Reagan era would still take 19 more years.

And maintaining that pace would be unlikely. The central bank has raised rates four times or more in only eight of the past 34 years, or about 31% of the time.

The challenges aren't merely statistical. The Fed is attempting to raise rates now at a time when economic growth in the U.S. and worldwide has leveled off well below pre-financial crisis highs, according to the World Bank.

As of March, personal consumption spending, one of the benchmark inflation measures used by the Fed, was up 1% from the year before. The central bank's goal is 2%.

"We saw weak growth in the first quarter of the year, and relatively weak growth at the end of last year," Fed Chair Janet Yellen conceded during  a presentation at Harvard in late May, "but growth looks to be picking up from the various data that we monitor."

That doesn't mean expansion will reach the highs of the past three decades, though. In addition to losing the boost of declining interest rates, the potential for corporate profit growth is lower and drivers of gross domestic-product gains like productivity improvement and population increases have weakened or stalled.

Those shifts, combined with the demise of traditional pension plans, managed by corporations to ensure consistent annual payouts to retirees for the remainder of their lives, will require consumers to manage their savings much more carefully. They'll want to limit administrative costs on 401(k) savings plans, to which employers typically contribute a defined amount, and weigh which investments are likely to perform best.

"We've lived in a world where the rising tide has lifted all ships," Dobbs said in the interview. Costs were less important because the returns were so large that investors benefited regardless, but "we're now in a world where returns are going to be less."

See full coverage on the Fed's upcoming interest-rate decisions.

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