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Are young investors afraid of owning stocks? Vanguard’s John Ameriks discusses Gen Y‘s attitudes toward risk and explains how to help them put market volatility in perspective.

Members of “Generation Y”—those born between the late 1970s and the early 2000s—have gotten off to a rocky start with investing. After all, this group’s first forays into the financial markets coincided with periods of severe volatility, from the bursting of the dot-com bubble in the late 1990s to the global financial crisis of the past decade.

Because of those unsettling experiences, it’s not surprising that many members of Generation Y—also known as “millennials”—are apprehensive about risking their money in the stock market. John Ameriks, head of Vanguard Investment Counseling & Research and coauthor of a 2011 research paper on different generations’ approaches to investing, says surveys indicate that Gen Y is less comfortable with equity risk than its predecessors. Ironically, though, these young investors actually have had greater exposure to stocks than previous generations at the same age.

We spoke with Mr. Ameriks to discuss this paradox, gain insights into Gen Y investors’ attitudes toward risk, and explore ways to help them put market volatility into perspective.

Based on your research, is it true that Gen Y investors are resistant to owning stocks?

It’s easy to look at the numbers, which say that overall equity ownership among younger generations of investors has fallen slightly in recent years, and conclude that this generation of investors will be condemned to live with lower expected returns over their lifetimes simply because the markets fell apart in their youth. The data do suggest that if left entirely to their own devices, younger investors might make overly cautious investment decisions.

But the good news is that because so many investors are automatically enrolled in defined contribution (DC) plans that invest in default funds with significant equity allocations, they’re getting asset allocations with stock exposure designed for a long-term retirement objective. In fact, when we examine their participation in DC plans, we see that younger investors actually have a greater participation in equities than their counterparts in previous generations did at the same age.

How do investors in Generation Y compare to their peers in Generation X?

Research by the Investment Company Institute shows a lower stated risk tolerance in Gen Y compared with what analysts observed in Gen X (those born between the mid-1960s and late 1970s) at the same age.* The patterns among this group of investors reflect the conditions they’ve experienced, such as the stock market downturn of 2008.

Interestingly, when we look at 401(k) data, we see that among investors who don’t opt to use a balanced mutual fund as their default, timing has a relationship to the asset allocation they choose. In particular, their allocation to stocks reflects the market environment at or just before their enrollment in the plan. With Gen Y this has meant an avoidance of risk, reflecting poor markets. But a decade earlier, the reverse was true—we saw an increase in risk-taking among Gen X as a result of the tech bubble before the new millennium.

How can more experienced investors help Gen Y put risk into perspective?

We all need to be sensitive to the anxiety Gen Y investors may have related to equities and be prepared to make the case for investing over the long term.

An experienced investor can really help Gen Y investors (or even older investors who simply aren’t as engaged) reexamine their assumptions and fears. When investors lack investment knowledge or are relatively disengaged or uninterested in the process, they may be more susceptible to market trends and “conventional wisdom.”

If you’re an engaged investor, you can help less experienced investors by providing some perspective and explaining the importance of taking a balanced approach to investing based on their goals and risk tolerance. By emphasizing the importance of asset allocation in achieving investment goals and by explaining the basic principles of investing for the long term, you can help young investors focus on finding a strategy that makes sense for their age and objectives—not on what has happened recently in the markets. Of course, you may want to suggest that they work with a professional financial advisor if specific guidance is needed.

How does the growing use of target-date funds (TDFs) fit into this picture?

These funds can be useful for investors who are younger or who have lower balances, and who may not have the time, experience, or inclination to create a completely customized portfolio. In addition, low-cost, diversified target-date funds with a stable “glide path,” constructed with either index funds (such as Vanguard Target Retirement Funds) or with minimal active management risk, can provide a well-diversified “core” retirement portfolio for just about any investor.

While a balanced target-date fund is designed to be an optimal default, it doesn’t pretend to be an unconditionally optimal portfolio—something that doesn’t exist. Our research shows that more than half of Vanguard investors who hold TDFs in their retirement plans invest in other non-TDFs as well. With a well-designed TDF at the core of your portfolio, there’s less work to do over time in terms of rebalancing and reallocating, and more opportunity for customization in other areas of your portfolio. We believe that sort of flexibility should have cross-generational appeal.

For more on this topic, see Generations: Key drivers of investor behavior, by John Ameriks and Steve Utkus, Spring 2011.

* Daniel Schrass and Michael Bogdan, “Profile of mutual fund shareholders, 2010.” Investment Company Institute Research Report (February 2011).

Notes:

* Please remember that all investments involve some risk, including the possible loss of principal. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

* Diversification does not ensure a profit or prevent a loss during a declining market.

*Investments in Target Retirement Funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in a Target Retirement Fund is not guaranteed at any time, including on or after the target date.
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An assortment of United States coins, includin...

An assortment of United States coins, including quarters, dimes, nickels and pennies. (Photo credit: Wikipedia)

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