Depression Babies and Risk-Taking

Good or bad investing experiences early in life leave a lasting impression that fades away only very slowly.

In Depression Babies: Do Macroeconomic Experiences Affect Risk-Taking (NBER Working Paper No. 14813), co-authors Ulrike Malmendier and Stefan Nagel confirm that experience over a lifetime strongly influences where households choose to place their investments.

Using the Survey of Consumer Finances for 1964-2004 -- which contains data on household investments, income, assets, and age -- combined with data on stock and bond returns, the researchers calculate "experienced stock and bond returns" for each household in their sample. These "experienced returns" are the weighted average of returns over the lifetime of each household (so far), where the weights are simultaneously estimated from the data. Malmendier and Nagel find that for those who lived during a period of high stock market returns -- inflation-adjusted experienced returns in the 90th percentile, or a rate of return of about 11 percent for the period 1964 to 2004 -- the investment of liquid assets in stocks is 5.7 percentage points higher than for those who lived in periods with experienced stock returns in the 10th percentile.

Experiencing returns in the 90th percentile also increased the probability that a household would participate in the stock market by about 10.6 percentage points. Similar results were observed in bond markets. Households that experienced inflation-adjusted bond returns in the 90th percentile, or a positive return of 4.6 percent, were 11 percentage points more likely to invest in bonds than those who experienced bond returns in the 10th percentile.

The Survey data suggest that 28.5 percent of the U.S. population participated in the stock market between 1964 and 2004. In the late 1960s, participation rates were above 30 percent and comparable to rates reached in the late 1990s. Participation rates fell in the 1970s and early 1980s. Although the authors find that households appear to place more weight on recent market returns, their results also show that good or bad investing experiences early in life leave a lasting impression that "fades away only very slowly."

-- Linda Gorman