Birth year trumps data in personal asset choices

A growing body of research suggests the era you grew up in is likely to influence your preferences on asset classes

It’s well known that asset allocation choices wax and wane according to underlying returns. When the stock market is on a downer, retail investors tend to sell. When it is rising, they buy. However, these are short-term cyclical phenomena. More recent research is suggesting that personal risk preferences may have deeper psychological roots.

It has long been assumed in the investment community that people have relatively stable risk preferences regardless of their economic experiences. It’s yet another classical notion being challenged by behavioral finance. A paper published titled Depression Babies: Do Macroeconomic Experiences Affect Risk-Taking? made a connection with those who experienced the Great Depression and their investing habits.

The authors, academics Ulrike Malmendier and Stefan Nagel, studied US consumer finance records from to and found that the impact of economic conditions and the performance of asset classes is particularly pronounced on the young. It can influence their risk tolerances and choice of assets during their lives.

“If you look at the long-term historical records going back decades, this is a systematic pattern,” said Stefan Nagel, professor of Finance & Economics at the University of Michigan. He explained that when stock markets go through prolonged periods of poor performance, younger people tend to get discouraged from investing in equities. It’s the opposite during bull markets.

DEPRESSION BABIES AVOIDED STOCKS

It’s well documented that US investors in the, who experienced the stock market crash and the Great Depression, shunned equities in favor of bonds. The US experienced a 20-year bear market, ending in the.

A modern manifestation of this behavior occurred in Japan. The McKinsey Global Institute noted that among developed nations, Japanese households stood out for their very low stock market participation. Attitudes changed after the-crash. From then onwards stock ownership by households plummeted from 30% to under 10% and never exceeded 18% – even though Japan’s two-decade bear market was punctuated by some strong rallies. By contrast, around 42% of US households had some non-retirement financial assets in stocks.

In other developed nations, Generation X () had a very different experience. Research by Bank of America Merrill Lynch says they enjoyed the greatest equity bull market ever. During the period, US total returns were 1,654%, compared with previous great bull markets, which returned 423% and 332% .

However, fast forward to the present and the latest generation of investors is wary of the “cult of equities.” If anything, they behave more like an investor readying for retirement, seemingly prioritizing return of capital over return on capital, which may not be so bad if Rob Arnott is correct in his arguments.

In April, Gallup found that just 27% of 18- to 29-year-olds claimed to own stocks, down from 33% in April. Among 30- to 49-year-olds, 67% held stocks – a group that encompasses most of Generation X and the oldest millennials. In the same year, a survey by UBS discovered that affluent millennials – so-called recession babies – held 52% of their wealth in cash and 28% in stocks, compared with 23% and 46% for older people.

“It’s what’s called the collective memory hypothesis,” said Victor Ricciardi, a finance professor at Goucher College in Baltimore and co-editor of the book Investor Behavior: The Psychology of Financial Planning and Investing with Kent Baker. He explained that emotional reactions to recent economic shocks have a greater weight on decision-making than longterm historical investment performance data or objective information.

However, there are some important caveats to be made before concluding that Generation Y is set to mirror the depression babies. “The millennials are a recent example of a younger generation experiencing severe economic shocks making them more cautious toward risky assets, but their reaction may not be as severe as the depression babies,” said Ricciardi.

Indeed, the major global equity indices sold off aggressively , but they have since recovered – most having surpassed their previous all-time highs. By contrast, Japanese investors and “depression babies” endured two-decade bear markets.

REGULATION DRIVES ASSET ALLOCATION

And there’s a structural reason, which is likely to ensure that many millennials will own equities. As Ricciardi pointed out, some countries have auto-enrollment pension plans – where money is deducted every month from salaries and invested into savings products. Many of those products will have an equity element to them.

Other types of regulation have a profound influence on asset allocation decisions. Thomas Richter, CEO of the German Investment Funds Association (BVI), noted in an interview with PROJECT M that in the US, equities are favored thanks to government tax breaks.

By contrast, the French regulatory framework has skewered investment flows toward money market funds. In Germany, different rules have instead fueled a huge market for endowment life insurance products. Nonetheless, US household ownership of stocks is declining. According to the US Federal Reserve, it fell from 53.2% to 48.8%. A survey by publishers Bankrate put the figure at 48%. It said the main reason cited for not investing was lack of funds – possibly reflecting the stagnation of US median incomes since. The second-most-important reason was lack of investing knowledge.

Other possible reasons for declining stock ownership could be because many investors got their fingers burned during the sell-off. Others are retiring and could be selling shares to invest in retirement products. However, the implications of Malmendier and Nagel’s research is that millennials may come to favor equities provided that equities continue their performance since the.

Birth year trumps data in personal asset choices

A growing body of research suggests the era you grew up in is likely to influence your preferences on asset classes

Birth year trumps data in personal asset choices

A growing body of research suggests the era you grew up in is likely to influence your preferences on asset classes

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