Young People Become Risk Averse

SmartMoney carried an item the other day about how, according to a new survey, those crazy kids have found another way to act foolishly. They are NYSE-floor taking less risk with their investments.

The factual basis for believing that younger people are taking less risk is a little thin, a single question on a survey of affluent Americans (Aflo-Americans?) done by Merrill Lynch. Still, it confirms my previously held beliefs and even fits into predictions of the future I made more than a year ago, so I am going to go with it.

52% of those under 34 described themselves as having a low risk tolerance. That is more than either the 35 – 50 age group (45%) or 51 – 64 group (46%). Only the oldest, and presumably retired, 64+ group came in at a higher rate of low tolerance, at 55%.

This is a direct affront to one of the more well established bits of personal finance pseudo-wisdom, that young folks should invest aggressively and then taper down the risk as they age. The SmartMoney article is filled with ominous hand-wringing about how recent volatility in stocks has caused an “emotional reaction” in the young that will cause them to impoverish themselves in old age by not taking on enough risk now.

I think that the high risk when young, low risk when old principle is, largely, bunk. While I agree that a person a few years from retirement, or in retirement, would rationally take less risk, for the long haul of saving, from early adulthood to late middle age, I cannot come up with a good reason why a person would change the risk level he took in his investments. In other words, if X% in stocks makes sense for a 25 year-old it ought to make sense for a 55 year-old and vice versa.

Yet higher risk when young is one of the more well entrenched bits of conventional wisdom. So well entrenched, in fact, that it is hard to find a written explanation of why it is a good idea, which presents problems for those of us who want to argue the other side. It is just universally understood as a baseline assumption of how people should invest.

But if it does not particularly make sense, where did it come from? My theory is that it started not as a prescription of how folks ought to invest but as a misleading late 20th Century observation of how they actually do invest.

Suppose, if you will, that people tend to settle on a risk tolerance with regard to the stock market based on how the market performed when they were in their 20s and 30s. If the market did well then, they will forever be risk tolerant, if it did poorly they will be risk adverse.

Now imagine it is the year 2000. Those under 40 can remember only the great bull market of the 80s and 90s. They think of the stock market as a free money machine and invest aggressively. The 40 – 60 year olds first learned about investing during the mixed bag of the 60s and 70s, so are naturally less keen on taking risk. And the 60+ crowd came of age in the eras of the Great Depression and Second World War. They think savings bonds are just fine, but cash in an old coffee can in the kitchen is a good idea too.

The mistake, of course, was to view these different generations as forming the stages of a life cycle of investing, rather than an accident of history. Young people are not naturally aggressive in their investing. People born in 1970 are, and will probably still be decades from now.

Taken in this light, it is not in the least bit surprising that those now under 34 are more risk adverse than the generations that immediately preceded them. They might dimly recall the waning days of the dot com bubble, but what really made an impression on them was the lost and unnamed decade of 2000-2009.

What now? I am not optimistic that the life cycle theory of risk aversion will die anytime soon. More likely, we are in for many years of pundits tut-tutting the younger folks for not taking proper amounts of risk.

Alternatively, and this really would not surprise me, somebody will back-fit a theory onto the facts, explaining why taking less risk when young, more when middle aged, and then less when old, makes sense. Conventional wisdom has been born from less.

No Comments

No comments yet.

RSS feed for comments on this post. TrackBack URI

Leave a comment

WordPress Themes