Posted by: Yuval D Bar-Or on Sep 01, 2010
When disasters occur, the full repercussions sometimes take years to manifest.
One example is the trend among young adults (ages 18-25) to shy away from equity investments. Having come of age during the crisis, and seen firsthand the devastation visited upon their parents and grandparents, this cohort appears to exhibit higher than average risk aversion. The higher aversion means they are investing less in equities, despite the empirical observation that equities outperform other investments over very long periods.
I was recently quoted on this subject by Joe Mont in TheStreet.com article “Young Investors Risk More by Risking Less” (August 18, 2010): “For many families, the recent financial crisis and its ongoing challenges are certain to lead to long-term issues … Shunning equities could mean much slower wealth formation, as historically equities have outperformed other asset classes over long periods of time.”
The overreaction by the younger cohort is a normal response to trauma. From a longer-term perspective, however, they may well be avoiding the very returns they need to secure their retirement nest eggs. Even small annual performance differences (say, between stocks and bonds) can lead to very significant wealth creation due to the power of compounding. By shunning equities, young adults, who are ideally positioned to invest for the very long term, are likely depriving themselves of a large amount of potential wealth accumulation.
I urge young adults to explore the literature on the subject. Many books on finance and investing have documented the long-term performance differences across different asset classes (stocks, bonds, and cash). The patterns are compelling and help to establish that diversified equity investments are crucial components of young adults’ long-term investment portfolios.