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Why should older people invest less in stock than younger people?

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Author Info
Ravi Jagannathan
Narayana R. Kocherlakota

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Abstract

Financial planners typically advise people to shift investments away from stocks and toward bonds as they age. The planners commonly justify this advice in three ways. They argue that stocks are less risky over a young person’s long investment horizon, that stocks are often necessary for young people to meet large financial obligations (like college tuition for their children), and that younger people have more years of labor income ahead with which to recover from the potential losses associated with stock ownership. This article uses economic reasoning to evaluate these three different justifications. It finds that the first two arguments do not make economic sense. The last argument is valid—but only for people with labor income that is relatively uncorrelated with stock returns. If a person’s labor income is highly correlated with stock returns, then that investor is better off shifting investments toward stocks over time.

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Article provided by Federal Reserve Bank of Minneapolis in its journal Quarterly Review.

Volume (Year): (1996)
Issue (Month): Sum ()
Pages: 11-23
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Handle: RePEc:fip:fedmqr:y:1996:i:sum:p:11-23:n:v.20no.3

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Keywords: Saving and investment Stock market

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Jagannathan, Ravi & Wang, Zhenyu, 1996. " The Conditional CAPM and the Cross-Section of Expected Returns," Journal of Finance, American Finance Association, vol. 51(1), pages 3-53, March. [Downloadable!] (restricted)
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  2. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-73, April. [Downloadable!] (restricted)
  3. Bodie, Zvi & Merton, Robert C. & Samuelson, William F., 1992. "Labor supply flexibility and portfolio choice in a life cycle model," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 427-449. [Downloadable!] (restricted)
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  4. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 5(3), pages 357-86. [Downloadable!] (restricted)
  5. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December. [Downloadable!] (restricted)
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  6. Rios-Rull, Jose-Victor, 1994. "On the quantitative importance of market completeness," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 463-496, December. [Downloadable!] (restricted)
  7. Narayana R. Kocherlakota, 1996. "The Equity Premium: It's Still a Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(1), pages 42-71, March. [Downloadable!] (restricted)
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