Millennials have been thought to behave more conservatively when it comes to their finances than older generations. But new data has revealed millennials have surprisingly similar levels of risk tolerance to older people. And while some do shy away from risk, millennials are the one demographic group that can't afford to lose confidence in investments.
The data, drawn from the
FinaMetrica Risk Profiling System between January 2012 and May 2015, found that individuals born between the 1980s and early 2000s do not possess a material difference in risk tolerance compared to Generation Xers born between the 1960s and early 1980s.
Indeed, according to FinaMetrica's data, there is a just a 48% chance of a 30-year-old being less risk tolerant than the average 45-year-old and a 52% chance of a millennial being more risk tolerant.
Comparing to an even older age group, FinaMetrica's data reveals 69% of millennials are, in fact, more risk tolerant than the average baby boomer, countering general opinion on millennial behavior that they shy away from risk. There is just a 31% chance of a 30-year-old being less risk tolerant than the average 60-year-old.
What our data shows is that millennials are no less risk tolerant than their Generation X or baby boomer counterparts. If it is true that millennials are more financially conservative, risk tolerance — or their lack of it — is not the reason.
So what is risk tolerance? Risk tolerance is a psychological trait that reflects how much risk a person is emotionally willing to take. This is different from risk capacity, which is the level of risk an individual can afford to sustain without derailing their short- or long-term goals.
(Related read: Millennials are saving, but their fear of stocks could hurt them)
Risk tolerance is typically set by early adulthood and it decreases only slightly with age. Clients' risk tolerance scores generally remain stable through the gyrations of the markets, though a major life event such as divorce or having children can change risk tolerance.
FinaMetrica believes that millennials' capacity for and perception of risk may be better indicators of their conservative behavior. Millennials who reached adulthood in 2000 have witnessed two major bear markets. There is high unemployment generally amongst young people in the U.S. and tertiary education debts are a big issue. These challenges have forced many millennials to delay certain milestones that have traditionally categorized adulthood, like home ownership and starting a family.
(More insight: Advisers should check assumptions at the door when determining client risk tolerance)
It is likely that many millennials were emotionally overexposed, still feel bruised and have remained sidelined, where they may stay for an extended period. The downside to this, of course, is that this reluctance to take on risk has crystallized their losses and has left many millennials out of the recovery given their underexposure to growth assets.
On the other hand, problems can also arise if millennials are not receiving proper investment advice and are placed into products which expose them to too much risk. In the U.S., a millennial placed into an increasingly popular target date fund would typically receive a 90% growth asset allocation.
However, according to FinaMetrica's data, this type of investment would be too risky emotionally for 96% of millennials. They are the one demographic group which can't afford to lose confidence in savings and investments. This is particularly true for female millennials who generally have a lower risk tolerance and live longer than their male counterparts.
Millennials are also unlikely to aggregate investable assets in the same ways and to the same volumes as their parents and grandparents. Their employment prospects are also entirely different. They are likely to live longer than their immediate relatives with the knowledge that state support will be negligible.
A point to note is that the difference in risk tolerance levels between age groups isn't that great. There is, in fact, much more variation within an age cohort than between age cohorts. In other words, an individual's emotional makeup can account for great differences in their appetite for risk compared to another person, regardless of age group.
Paul Resnik is the co-founder and co-director of FinaMetrica, a specialist in risk tolerance and risk-related matters.
