Young people experiencing the current economic downturn will be less likely to reinvest in the stock market than older investors who have lived through times when the market was paying high returns, says a new study by two California business professors.
The study's results may be the first hard evidence to show that the economic times a person lives through may have a long-term effect on his or her future investment strategy. The implication is that difficult economic times will make people, particularly younger ones, less likely to invest in the future.
"This can amplify recessionary effects, and prolong economic downturns," says Stefan Nagel, associate professor of finance at Stanford Graduate School of Business. The report, "Depression Babies: Do Macroeconomic Experiences Affect Risk-Taking," is co-authored by Ulrike Malmendier, associate professor of economics at the University of California, Berkeley. Because bad economic times make investors skittish, it can lead to a vicious circle, the study says.
Investors who experienced high stock market returns throughout their lives are more likely to invest a higher percentage of their wealth in stock. Those who experience high inflation prefer inflation-proof cash-like investments, the study shows.
Young people, "because they have a limited history, are much more likely to change their [investing] behaviour due to a single year's performance in the markets, than an older person, who might have several decades of experience," Nagel concludes.
Nagel and Malmendier were unable to determine if a severe downturn has a more lasting effect than a milder one. Next, they want to determine if economic experience changes a person's risk tolerance or changes their belief in the operation of the system itself.