Young Investors Stand To Benefit

History Shows Those Buying In Down Times Do Very Well On Upswing

July 14, 2009

Investors of all ages have seen their portfolios take a hit in this bear market. But will losses have a greater effect on younger investors, making them less likely to buy stocks in the future?

Some academics think so.

With little investing experience under their belt, young investors might conclude they should avoid stocks after last year's market plunge. Yet, if history is any guide, young investors could become big winners if they invest in stocks during a bear market and reap the rewards when those shares appreciate later in a bull market.

"A lot of this depends on experience. Look at a young person today. Their experience of the stock market is dominated by these poor returns," says Stefan Nagel, an associate professor of finance at Stanford University.

A sudden market rebound will lessen last year's impact on twentysomething investors, he says. But if stocks remain flat or worsen, then this experience could have a long-lasting effect on them.

That's happened before. A study by Nagel and a colleague found that investors in their mid-20s to mid-30s in the 1970s - a decade with one of the worst bear markets - tended to hold less stock going forward than their counterparts who came of investing age in the 1990s bull market. And they also tended to be more cautious than investors age 55 and up who knew from experience that markets can rebound.

Of course, one big difference between now and then is the emergence of the 401(k). Many employers today automatically enroll young workers in the plan, often directing their contributions to portfolios with a significant concentration of stocks. Young workers might not bother to change their 401(k) investments, even if they are uncomfortable with stocks just now.

Still, Christine Fahlund, senior financial planner at T. Rowe Price Associates, says she's concerned that young investors will become stock-shy when "this is a great opportunity they shouldn't miss out on."

Price recently studied the impact of investing in bear and bull markets, looking at four workers investing $500 a month in a portfolio mimicking the S&P 500 index. Each starts buying stocks in a different year - 1929, 1950, 1970 and 1979 - and continues to buy shares and reinvest the dividends over three decades.

Those entering the market in 1929 and 1970 were soon hit with severe bear markets; while the other two are starting as the market begins a bull run.

Bear market investors were able to accumulate more shares because they were buying when prices were depressed. The Depression-era investor ended up with more than 84,000 shares after three decades compared with, say, the 1979 bull market investor who accumulated 9,556 shares.

Each invested $180,000 over 30 years. The end result: The investors starting with a bull market - 1950 and 1979 - ended up with about $809,000 and $898,800 respectively. Not bad. But the portfolio of the Depression-era investor grew to $1.9 million, a 960 percent return. And the investor starting prior to the 1970s bear market accumulated an amazing $3.3 million for a 1,753 percent return, thanks in part to the roaring markets of the 1980s and 1990s that followed.

Tom Coale, a 28-year-old from Ellicott City, doesn't need convincing to stick with stocks.

Though his retirement account at work took a drubbing last year, Coale says he continues to contribute, figuring he doesn't need the money for decades and he's buying shares at a discount. He also invests outside his retirement plan, taking advantage of falling prices to buy stocks that had been out of his wallet's range, such as Apple.

But this bear market has left a lasting impression on him, he says. Some of his older co-workers suffered losses by bailing out when the market went into a tailspin last year. "They said they couldn't stand to watch it go down," he says.

Coale says their experience will serve as a reminder to adopt a more conservative portfolio as he nears retirement.

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