Wednesday, August 17, 2011

Modern-Day Recession Babies


My mom was a Depression Baby. Depression Babies were born in, and around, the 1930’s…and grew up during a decade of sacrifice and want. Like many depression babies, my mom was frugal, and saved everything. One look in her refrigerator gives a good clue. (She still calls it the “icebox.”) The refrigerator shelves are chock-full of leftovers…of indeterminate provenance.

My mom was sneaky too. Once, during a holiday visit, I spied a small bowl of ambiguous brown bits in the fridge. It looked like it might have been ground beef…accept for the whitish-grayish film that obscured the top. I mentioned this to my mom. She thanked me for the “heads-up” on the past-due leftover. That night for dinner, she made spaghetti, and the bowl of unknown substance was mysteriously gone…as was my appetite!

New Study on Investment Behavior
There’s an interesting study coming out of Stanford on how our economic experiences affect investment behavior. Stefan Nagel, a professor of finance at the Graduate School of Business, has demonstrated that personally experiencing an event like the Great Depression has a significant impact upon how we invest our money.

If you are a financial advisor, as you read this you may be saying something to yourself like, “I sure don’t need a Ph.D. in Finance to tell me that!” (Which Stefan Nagel has, by the way.)

Yet, surprisingly, until now there has not been hard research that economic events can actually change investment behavior. What Professor Nagel did was to compare 47 years of household asset allocation data and stock-market participation figures from the Federal Reserve’s Survey of Consumer Finance…and cross-correlated this against the investor’s economic experience.

Among his findings:

  1. Individuals who had experienced high stock-market returns throughout their lives were less risk adverse, and more likely to participate in the stock market. (For example, older investors, who had memories of the better market returns of the ‘50’s and ‘60’s were more likely to invest in stocks as compared to those investors who experienced the low returns of the ‘70’s and early ‘80’s.)
  2. Alternatively, those who had experienced high inflation were less likely to invest in bonds, preferring inflation-proof cash-equivalent investments.

Recession Babies?
What makes Professor Nagel’s research especially timely is the remarkable market volatility of the past few weeks, and recent articles like this from this past weekend’s NY Times, Small Investors Recalibrate After Market Gyrations…which leads to investor beliefs like the following, “I don’t think there’s a reason to buy on the dip because the dip isn’t done.”

Indeed, one wonders if the 4% daily swings in the market aren’t helping to create a new generation of
risk-adverse, Modern-Day Recession Babies.

Beliefs and Risk Preferences
For financial advisors, Nagel’s research might also be instructive in learning more about your client’s investment beliefs and risk preferences. Advisors might consider incorporating some of the following questions as they strive to achieve a deeper understanding of the investment concerns and expectations of their clients:

  • How have your own market experiences affected your investment beliefs?
  • How well, or poorly, do you think that the stock and bond markets will do over the next 10 years? (This is their belief.)
  • I’m curious, based upon your market belief, how might this affect what you are willing to do from an investment standpoint? (This is their risk preference.)

If nothing else, I would think that these questions would stimulate a thoughtful discussion on return expectations and risk tolerance.

by Chris Holman

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