A new study by Stanford University and Northwestern University’s Kellogg School of Management indicates younger investors may make smarter choices. Older investors are more likely to take bold risks, which can lead to greater losses. See the following article from The Street to learn more.
When it comes to financial decisions and investing strategies, who does a better job: young, tech-savvy investors or their conservative, old-school elders?
Bad news for the adults: Research by Stanford University and Northwestern University’s Kellogg School of Management found evidence that older investors may be more prone to make bold moves and bad choices.
In technical terms, "a variability in nucleus accumbens activity" may be to blame for irrational financial decisions made by some older investors. Put more simply: daydreaming.
The researchers found evidence that older investors are more prone to distractions and wandering thoughts that result in taking unnecessary risks and choosing stocks that they should otherwise have known to back away from. Poor decision-making isn’t necessarily the result of senility, memory lapses or other cognitive declines that go hand in hand with aging.
As part of their study, men and women between the ages of 19 and 85, while having their brains scanned by an MRI, were put through a game that involved choosing among various stocks and bonds. Older subjects proved just as willing as younger ones to choose riskier investments, stocks over bonds. But the older participants more frequently made rash decisions, choosing stocks before they even considered performance and earnings data available to them. In some cases, they were well aware of companies’ earnings, gains and losses, but chose weaker offerings nonetheless.
It wasn’t forgetfulness that led to bad choices, but what the researchers referred to as "noise" — other thoughts "leaking" into the task at hand.
In terms of brain chemistry, the release of the neurotransmitter dopamine — traditionally thought to decline with age — spiked during the experiment and could be partly to blame for the randomness of the choices made.
"We don’t know a whole lot about how aging affects decision-making, particularly in the financial realm," says Brian Knutson, associate professor of psychology and neuroscience at Stanford University. "This is becoming increasingly important because the global population is aging, and so the financial decisions people make as they age are going to become an increasingly important aspect of the economy."
Beyond dopamine flashes and senior moments, there are differences in perspective between older and younger investors that can influence their moves, for better or worse.
Steve Johnson, a Boston area financial consultant for Charles Schwab (SCHW), says recent surveys have shown that younger investors are feeling less confident in their financial decisions.
Even if older investors are more confident about their moves, "it doesn’t mean those are really the best decisions," he says.
Older investors often "anchor themselves into things that have happened in the past," Johnson says. The fear of rising inflation is one such example, as they flash back to the double-digit increases of the 1970s and "have convinced themselves that we have to see it again."
"Older investors are more reluctant to buy into fixed income," Johnson says. "After several years of seeing the market go down, we saw a lot of money poured into fixed income; now we see that income coming out as people start to be fearful of inflation. And yet, for those who are retired and looking for income, perhaps the best decision for them is to be looking at that allocation."
Older investors, he says, also tend to be creatures of habit when it comes to the stocks they choose, returning to stocks they and their parents were most familiar with over the years — such companies as Exxon (XOM) and General Electric (GE).
"People tend to not look at [familiar companies] objectively and often own those stocks despite what the fundamentals may say," he says.
"Some of the older people, if they are more conservative, are going to look for dividend-paying stocks or dividend-paying mutual funds," says Rosanne Rogé, managing director of R.W. Rogé & Co., a New York-based wealth management firm. "The younger people are going to be a little more aware of other things they can invest in, like ETFs or emerging-market funds, something that will give them a little more bang for the buck. They have so many more choices than the older folks did. Back then, it was basically all about blue chip stocks."
Conventional wisdom is that younger investors are brash risk-takers and older folks are more cautious and methodical. Numerous post-recession studies, however, are finding that the opposite is true in many cases, with Generation Y and the even younger "millennials" proving to be skittish and risk averse when it comes to playing the market.
Johnson sees their approach as understandable. These are age groups that, thus far in their short lives, have witnessed the tragedy of 9/11 and lived through a recession, bursting sector bubbles, the collapse of the housing market and bailouts of "too big to fail" financial institutions.
"People have the sense that the market is against them," Johnson says.
An upside may be that the younger set may be more serious about paying off debt, increasing their savings and planning for the future.
"One of the positives coming out of the financial crisis is that we are starting to see a more responsible generation, one that says, ‘debt was a bad issue for my parents — and I don’t want that to be me.’ After seeing the damage that was wrought over the past couple of years, and how it impacted their parents, the younger generation says they can’t afford to have that much volatility and that much movement within their portfolio and savings. They think, ‘If I can invest this conservatively, and save more frequently, that’s a much better plan than going at it with an aggressive portfolio and hoping that over time it does well."
Rogé says perspectives are shaped depending "on when they first got into the market."
"Those in their 30s and 40s are OK with taking on a little more risk," she says. "The ones in their 20s were just started to get involved in the market when they saw their 401(k) values go down. They are the ones who tend to be a little more conservative, because they’ve been burned — and burned badly. The 30- and 40-year-olds, they’ve been there and done that. They know it comes back at some point, so they are willing to take on more risk. Not a lot, but a little bit more."
Younger investors are often better educated and more savvy about financial decisions than their elders were at their age, Rogé says. That is partly due to the volume of news and guidance available to them. It also springs from the reality that they, unlike the pension-collecting generations before them, have to take control of their own retirement plan.
"When your dad or my dad left the company, they received a gold watch and they got a fixed pension," she says. "They didn’t need to have any other education. They knew what was coming in and provided for them, so any other money they had was usually in a savings account. They weren’t much into the market back in those days. These kids today are really going to have to really rely on it. They have no choice."
This article was republished with permission from The Street.