Looking beyond the nation's stubbornly high jobless rate, the worst effects of the Great Recession may be slowly receding in the rearview mirror. But advisors are waking up to the fact that the shockingly steep drop in equities and Americans' retirement savings in 2008 has left a profound-and possibly permanent-psychological impact on younger investors.

There's no doubt the recent crisis in liquidity struck fear into the hearts of tens of millions of Americans in Generation X-those born around the tail end of the baby boom generation, about 1965-and Gen Y, which refers to people born after about 1985. What set the Great Recession apart from other steep corrections of the past few decades was not only its severity, but also its clear impact on younger Americans' sense of financial security, their faith in financial institutions and Wall Street, and their willingness to invest in equities for the long haul.

"It can directly and indirectly affect you," says Jay Park, a computer science and engineering student at the Georgia Institute of Technology who echoed the impact the recession has had on many of his generation. "Financial instability can completely ruin someone's outlook on life and turn someone into a dire pessimist."

Psychologists and sociologists typically find that most people's viewpoints on economics, finance, politics and society are shaped when they are entering adulthood in their impressionable late teens or early twenties. However, a seismic event like a world war or a near depression can also alter people's psyche when he is older.

Advisors may lump Generations X and Y into one group as tomorrow's clients, but their experience with the economy and financial markets differs dramatically. Generation Xers came of age financially during the explosion of equity prices in the 1990s. "Their first experience with investment risk was the tech wreck," says Steve Gresham, senior vice president, private client group at Fidelity Investments. "Many investors bought high-flying names thinking 'Things were supposed to be different this time.' "
Contrasts in outlook can be stark even among young adults fairly close in age. Kevin Gannon, a real estate consultant in Toms River, N.J., notes his 30-year-old son, who was in his late teens at the tail end of the tech bubble, believes that if you make enough wild bets, one will turn out a winner. His 22-year-old is much more cautious and conservative.

A lot of younger workers-particularly those on the leading edge of Gen X-have money to invest, says Bill Finnegan, director of global retail marketing for MFS Investment Management. But they're also navigating midlife financial challenges like big mortgages on houses that are under water and education costs for their own kids. The Great Recession didn't help.

Last year MFS conducted a survey on the investment attitudes of younger Americans that painted a portrait of a new generation of reluctant, gun-shy investors who are leery of investment advice, confused about their financial options and more conservative in their approach to savings and capital gains than were their baby boomer parents and older siblings. "Our results show confusion for Gen X/Y investors, with many considering themselves to be savers, not investors, and looking to their investments to generate income instead of capital appreciation for long-term goals," says Finnegan. Gen X individuals are now "facing those life decisions you're confronted with when you have kids and a home and a spouse and all the stuff that goes with it."

Nonetheless, investors under the age of 45 appear to have turned more optimistic in the last six months, as 42% of Gen X/Y folks in MFS' latest survey released in April indicated they increased 401(k) and/or IRA contributions and 36% said they were willing to assume more investment risk. Fully 55% of Gen X/Y investors reported that an effective portfolio should include international investments, more than either baby boomers or people over 65.

Both the X and Y generations also grapple with a savings and investment psychology tempered by the financial meltdown and other large-scale, macro-level threats. "The news gets amplified, but over the last ten years, you're looking at the dot-com/tech bubble burst at the beginning, you have the Great Recession at the end, this terrible liquidity crisis, and in the middle of it you have wars, terrorist attacks, tsunamis, hurricanes," Finnegan says. As for the recession, he adds, "I think the impact has been very severe. I don't think it'll be as long-lasting [as the Great Depression], but I do think it was probably as severe."

In its wake, he observes, the MFS survey found a generation scarred by the financial meltdown and other jarring events. Finnegan calls that shift "certainly understandable, if you look at these folks' formative years-between 18 and 28. If you look at the last ten years of the stock market and the nightly news, that can scare the bejeebers out of anybody."

That change in psychology has often been overlooked, he notes. "I think the asset management and financial services industry spent a lot of time talking about investing for your retirement. It looks like the terminology for [younger workers] may have changed to saving for retirement."

Since the oldest Gen Y individuals are 26 years old, what exists of their consciousness has been formed over the last decade. While the details in the psychographic portrait of these individuals have yet to be fully defined, certain issues are surfacing. Many in Gen X and Y are the offspring of baby boomer parents, who represent a larger, more dispersed demographic. As one observer puts it, their boomer parents got "the stuffing knocked out of them much later in their game" than their children.

Mellody Hobson, president of Ariel Investments, thinks these "modern-day  Depression babies" represent a silver lining for the economy and the financial markets. Like the grandparents of Generations X and Y who became the greatest savers of the last century, a whole set of systematic activities has shifted in short order, including more thoughtful attitudes toward credit card debt, down payments for mortgages and work.

Young people "looking for work today show a lot more appreciation and gratitude," Hobson says. There is a "Give me a chance, put me in, Coach" attitude she sees that could translate into "better careers" for many.

Hobson also views their skepticism toward equity investing as healthy. "They are so young they'll see all sorts of market cycles, and this may have been the worst market cycle they'll ever see," she explains.

Boomers received their first encounter with investment risk in the 1987 stock market crash, and with subsequent, less-dramatic corrections. But the real lesson many of that generation took away from swooning equity prices was that the stock market always comes back and reaches new highs. That was before the so-called lost decade when they learned the wait could be a long one.
More money is being squirreled away in banks and money-market funds than it has been for decades. "Eventually, savings will translate into loans, which will translate into jobs," Finnegan says.

A big question facing Gen Y folks is how much of their attitude will be shaped by what their parents wanted for them. Gresham notes that older boomers, enjoying both a bull market and a buoyant economy, "tried to make life a lot better for their kids," and ended up outdoing their own parents at pampering Generation Y. But events like the Great Recession have a way of overpowering parental aspirations and sobering a young generation up quickly.

For both Gen X and Gen Y, those events have spawned "a lot of mistrust" about investment advice and the counsel provided by the financial community, warns David Lutz, a certified financial planner with The Advisors Group of Pittsburgh. Along with that mistrust has come greater resistance to investing.  "Unfortunately, a lot of people have heard the stories about Bernie Madoff, and feel that every advisor is just like that. That is very hard to overcome," he says.

Faced with that degree of skittishness among younger investors, "You've got to build up that trust every day, because the generation is so skeptical of what people tell them," Lutz notes. "You've got to prove it to them, and show them that [investing for the long term] is the right way."

The impact is even more profound, he noted, for "anybody who experienced a foreclosure or a job loss. That will affect them for the rest of their life."

Other financial advisors see similar trust challenges. "There's a much deeper level of skepticism, for some good reasons," says Michael Kitces, director of research at the Pinnacle Advisory Group in Columbia, Md. With Gen X and Y, he adds, investment advice "starts to become an issue of credibility."

The reason for the credibility gap isn't hard to understand. Given the huge drop in equities spawned by the banking, housing and liquidity crises, says Kitces, the financial community has essentially "given advice that hasn't worked in a decade. A lot of folks have been out of school and in the work force for a decade or more," he points out, and for them, "there's still no appreciation in equities." Their investing experience thus far, he added, is in stark contrast to that of the baby boom generation, whose attitudes about investing were forged by "a tremendous bull market."

Under the current conditions, Kitces notes, it may take a long-term, sustained rise in equities to pull younger investors back into the market with any degree of enthusiasm. "If we continue to have this kind of up and down market, it's going to be hard to win their trust. You can get a generation back" into the investment arena, adds Kitces, "but I think we're at a pretty delicate point right now."

Watching what happened to the 401(k) plans of their parents-the original "Don't trust anyone over 30" cohort-has only exacerbated the trust issue for Gen Y. But most of their parents stayed the course with their 401(k) allocations and kept contributing, so this dynamic could play out positively. "Account balances are back near their 2007 high," says Hobson.

There is another factor at play with both Gen X and Y. "Investing for a huge chunk of Gen X and Y is not a vocation or even a hobby," Fidelity's Gresham says. "Many investors will look for better education and decide how much they want to do on their own."

The impact, of course, is hardly limited to younger investors. A recent survey of more than 1,000 wealthy U.S. investors by Cisco Internet Business Solutions Group [IBSG] found widespread concern among all age segments about their financial future, and increasing skepticism about "the efficiency of the financial markets." Half of those respondents also "expect that they will be forced to delay their retirement due to the poor?performance of their investments," Cisco found.

Additional research paints a similar picture. The fifth Heartland Monitor Poll from The Allstate Corp. and the National Journal, released last year, found a deep-seated anxiety-and a craving for stability-among the "millennial" generation of Americans aged 18-29.

"While most Millennials have been able to make ends meet, they are having a hard time managing debt and saving for the future," says Allstate Chairman, President and CEO Thomas Wilson.

According to the Heartland survey, only 16% of 18- to 29-year-olds say they can live comfortably and save an adequate amount on their current incomes, and 32% say they "find it hard to make ends meet every month." And fully 46% of them say paying for a four-year college degree is an economic burden. More than half of respondents, 55%, say their goal is long-term employment with a single employer, not unlike their grandparents who grew up in the Great Depression.

Compared to their grandparents, the so-called organization men who participated in the post-World War II economic boom, younger Americans have learned it's a dodgy proposition to count on a large corporation for safety and security.

More telling from the standpoint of the financial services industry, "Given a hypothetical $100 to invest, millennials preferred saving in a bank or paying down debt to buying a home or investing in the stock market," notes Allstate.

"Buffeted by this tempestuous economy, many millennials are urgently seeking shelter from the storm," wrote Ronald Brownstein, political director of Atlantic Media, publisher of the National Journal. "Their generation is renowned for placing a high priority on personal expression, making a difference in society, and accumulating fulfilling experiences, and those instincts still resonate through the poll. But across a wide range of economic choices, the survey finds that the ferocity of the recession has left this generation with a powerful craving for certainty."

Lutz, who is 39, echoes the feelings of many of his Gen X peers about the diminishing opportunities for younger Americans. "The baby boom generation seems to want it all. They want the big house, the car, the vacation, the pension, Social Security, retiring at 62 - but not taking into account the long-term effects, and what that's going to do to our generation.

"We'll be the ones who will have to clean it up, most likely. We'll probably be the ones who will see the cuts in Social Security benefits and have to work longer. So I'm very distrusting of a lot of people, and I think I see a lot of that in the Generation X too," Lutz added. "We try not to rely on anybody, even the government, for benefits."

Indeed, both Gen X and the generation of Americans now entering adulthood have little faith in the ability of government to provide for their financial security later in life. "I'll definitely invest in my retirement," says Park, the Georgia Tech senior. "I'm not sure Social Security's going to be doing that great by that time, so I'm going to make sure I have an investment plan."

For Jon Dilling, a 41-year-old editor for Turner Cartoon Network, the meltdown in equities in 2008 "wasn't totally unexpected." But it did bring for him and his wife "this initial shock," he says. "In an abstract way, I knew that day would probably happen. But it was a little jarring to watch your account drop by nearly half its value in a short period of time, and be left in the position of [asking ourselves] 'What do we do now?'"

Luckily for him, he said, "Being the age we are, we're going to just ride it back up. But we have friends who are 20 years older than us, and we've seen their lives impacted in a much more dramatic way, where they're a lot closer to retirement."

Dilling says the meltdown in his equity portfolio has tempered the formerly high degree of risk tolerance he and his wife had for investing. "When you're young, you feel invincible and that you can weather any storm, and that you could start all over again from a zero balance," he explains. "But now that we have something to lose, I realize that safer investments later in life actually make a lot more sense, after having been through the recession. I understand the importance of maybe dialing it back later in life, when you don't have as much time to rebound from those downswings."

One financial counselor with a front-row seat on the impact of the Great Recession on the newest generation of adults is Deena Katz, who is chairman of Evensky & Katz in Coral Gables, Fla., and an associate professor teaching personal financial planning at Texas Tech. "This generation," she observes, "is seeing what's happening to their parents' retirement plans, and how that's become a real problem for most of them and how they need to change their expectations.

"A lot of the boomers today came through the '90s when you could invest in anything and it made money," Katz says, laughing. "But these kids have seen first-hand what deflation can do, particularly in real estate. They've watched their parents' homes diminish in value, and they've seen the lack of financial literacy in this country. They have seen firsthand what mistakes [our generation has] made, and they're not going to make those mistakes."

Consequently, Katz notes, "this generation is starting early to save. They want some control over what happens to them. But I think they're a lot more realistic about investing and how much control they have over their own future."

Katz says her students are also becoming "a little more realistic about their capabilities as an employee. They expected to graduate making $60,000, $70,000 a year, and they recognize that's not going to happen right away," she says.

Ultimately, Generations X and Y will see their futures determined largely by their ability to adapt to change. The biggest difference between these generations and their predecessors is that the world has grown increasingly complex and three-dimensional. The days of linear career tracks and defined benefit plans are over. Today's young adults will have to create their own career paths and retirement trajectories.