Will Recession Forever Scar Young Investors?

People who lived through the Great Depression were shaped thoroughly by the experience — so much so that many of them never gave up habits of extreme thrift, aversion to financial risk and even hoarding behavior.

As we begin the long climb out of the Great Recession, a question presents itself: How will this experience shape this generation’s minds and habits going forward?

A pair of recent studies may shed some light. The cognitive effects of financial shocks are long-lasting — and for those who go through them in early adulthood, can shape one’s entire outlook on life.

Take the findings of Paola Giuliano and Antonio Spilimbergo, presented in a recent National Bureau of Economic Research paper. Using data from the General Social Survey and matching it up with data on regional recessions in the United States between 1972 and 2006, the authors found that “individuals growing up during recessions tend to believe that success in life depends more on luck than on effort, support more government redistribution, but are less confident in public institutions.”

But what was truly striking was that this finding only held if the person was in his or her “formative years,” between 18 and 25, during the financial shock. Being exposed to a recession before the age of 17 or after the age of 25 had no effect in the data they studied.

How can this be? It’s not that people’s beliefs can’t change — and certainly not that an individual’s beliefs might not change. But social psychologists have found that humans, in the aggregate, are flexible and responsive to social circumstances when they’re young, but become far less flexible as they get older. Old dogs stick with the tricks they know.

To see just how substantially our experiences can influence our future behavior, take a look at another recent NBER paper. Ulrike Malmendier of the University of California, Berkeley and Stefan Nagel of Stanford University looked at the investment behavior of people who experienced the Great Depression in young adulthood. They found that these “Depression babies,” once they reached midlife, had only about a 13% participation rate in the stock market. Understandably, these folks were largely spooked out of the market for life.

By way of comparison, the cohort that came of age during the post-World War II boom, by the time they reached midlife, had a stock-market participation rate more than twice as high as that of the Depression babies.