Are Young Investors on the Right Track?

This entry is part of a monthly finance blog I will be writing for Access Tallahassee (a division of the Greater Tallahassee Chamber of Commerce).  You can view the post on their website, alongside other blogs from the region's young professionals.

In a timely report this September, MFS Investment Management published a sentiment survey focused on Generation Y investors (age 18-30 may relate to anyone). MFS found that younger investors are anxious about their investments, and as a result they are investing conservatively. I had already guessed as much gauging from conversations with my peers, but the report puts some hard numbers behind my worrisome suspicions.

So why does it worry me that Gen Y investors are being conservative with their money? In short, if investors want a comfortable retirement, they need to grow their money, and most likely they will need to grow their money at a faster rate than a conservative portfolio will accommodate.

There is a general consensus among the investment community that the younger an investor is, the more risk that investor should be willing to take with their investments. This theory relies on a few basic tenets of investing, primarily the idea that, over time, investors are rewarded for taking on risk. The more risk an investor takes, the higher their expected returns should be.

Of course, investors who will need to access their money sooner rather than later do not want to take on significant risk (rightfully), so they lower their risk in exchange for lower expected returns. Younger investors, however, are typically great candidates for taking on risk for two very straightforward reasons:

• They have plenty of time to make back any losses, and
• Their current savings likely make up only a small slice of their total life savings (so even if you are risking 100% of your current savings, perhaps you are only risking 5% of your lifetime savings)

Unfortunately, today’s young professionals are setting aside these ideas and choosing to be significantly risk averse. While most advisors suggest that individuals become more conservative as they age, MFS finds that Gen Y investing habits already resemble those of their Baby Boomer parents. In fact, on average Gen Y investors have more cash in their portfolios than any other age group in the survey.

With growing life expectancies, rapidly rising health costs, an expanding political will to dismantle social safety nets, and the need to keep up with inflation, young investors will likely need to save at least as much as the generations before them, and will likely need to save even more. Unfortunately, with 38% of them living paycheck to paycheck, it does not look like they are on track to do so.

We can cut this generation some slack, however. Another recent study indicates their risk aversion is a byproduct of the times. In the paper “Depression Babies: Do Macroeconomic Experiences Affect Risk-Taking?” by Stefan Nagel and Ulrike Malmendier, they concluded that experiencing negative economic events leads investors to be more risk averse. Gen Y investors have experienced two major market crashes in the last 12 years, and few are likely to recall the booming markets of the 80s and 90s. This leads them to be more risk averse than their parents and grandparents. This same phenomenon was evidenced in those who came of age during the Great Depression.

Today’s investors have an advantage over the “Depression Babies,” and that is knowledge. An awareness of how our psychology affects our actions gives us the power to invest rationally and objectively. Younger investors are informed, innovative and optimistic, and though they may be off to a slow start, they have the tools to be successful.