How Did the Great Financial Crisis Affect Portfolio Allocations and Attitudes towards Risk? Evidence from the 'Survey of Consumer Finances'

Abstract

The Great Financial Crisis that began in 2008 took a heavy toll on household financial positions. Such episodes in the past have had long-lasting impacts on investor attitudes towards financial risks, and on portfolio allocations. After a period in which many investors chose to take large amounts of financial risk, this suggests the possibility that the pendulum might swing too far the other way, towards overly conservative portfolio decisions. Given the well-established tendency of certain risky assets, especially corporate equities, to outperform over longer holding periods, such a development could hinder the ability of investors to invest appropriately for retirement. We analyze portfolio decisions of younger (under 35) and older (over 55) investors using data from the Federal Reserve’s Survey of Consumer Finances (SCF). These investors suffered large losses during the recession. The portfolio allocations of younger investors to risky assets declined in 2010 to the lowest in the history of the SCF. This contrasts with their stated willingness to take on greater financial risks in hopes of a higher return. This “retirement paradox” could be a result of low levels of financial literacy that might inhibit investors from choosing portfolio allocations that are more consistent with their apparent risk preferences. We discuss how Target Date Funds may be an appropriate investment vehicle for such investors.