High-risk investing is better for the young? Why?

Question

I have heard statements such as the question's time.

Basically, it's a financial motto: "If you're young, take on more risk."

I don't really understand it. I figured risk-tasking is a personal/personality kind of thing -- not necessarily a young vs. old/older kind of thing.

What is the importance or benefit of the assumption that high-risk is preferable for younger people/investors instead of older people?

Me? I personally believe risk is more rewarding potentially, so it's worth it (yes, I am young).

I throw around $500 a week in to stocks, gold, and other small projects (I have a high-risk portfolio of around $20,000.00 so far). I plan to be a hedge funds manager or the like. Would my high-risk investment choices, aside from the main question, have any bearing on the road I want to go down and test (managing mutual/hedge funds)?

Answer 1

What is the importance or benefit of the assumption that high-risk is preferable for younger people/investors instead of older people?

Law of averages most high risk investments [stocks for examples, including Mutual funds]. Take any stock market [some have data for nearly 100 years] on a 15 year or 30 years horizon, the year on year growth is around 15 to 18 percentage. Again depends on which country, market etc ... Equally important every stock market in the same 15 year of 30 year time, if you take specific 3 year window, it would have lost 50% or more value.

As one cannot predict for future, someone who is 55 years, if he catches wrong cycle, he will lose 50%. A young person even if he catches the cycle and loses 50%, he can sit tight as it will on 30 years average wipe out that loss.

Answer 2

The reason that you are advised to take more risk while you are young is because the risk is often correlated to a short investment horizon. Young people have 40-50 years to let their savings grow if they get started early enough.

If you need the money in 5-15 years (near the end of your earning years), there is much more risk of a dip that will not correct itself before you need the money than if you don't need the money for 25-40 years (someone whose career is on the rise).

The main focus for the young should be growth. Hedging your investments with gold might be a good strategy for someone who is worried about the volatility of other investments, but I would imagine that gold will only reduce your returns compared to small-cap stocks, for example. If you are looking for more risk, you can leverage some of your money and buy call options to increase the gains with upward market moves.

Answer 3

There's two reasons. One is that you have a longer time horizon, other answers cover that.

The second is that for someone who is younger, most of their capital is human capital in terms of their future work output (and earnings). If you're 25 and your $20,000 portfolio gets wiped out, that's only a small amount of your total earnings. You still have 45 years in which to earn money (and invest it). If you're 65 and your $1,000,000 portfolio gets wiped out, you're in much bigger trouble.

Note that this means that in certain circumstances, a younger investor would want to be more conservative. If you're 25, but got a million dollar settlement for an injury which means you can't work anymore, you want to be more conservative than your average 25-year-old. If you're 65, and just sold a business for which you get $1,000,000 in two years, you can be more aggressive with your currently invest-able portfolio.

Answer 4

If you spent your whole life earning the same portfolio that amounts $20,000, the variance and volatility of watching your life savings drop to $10,000 overnight has a greater consequence than for someone who is young. This is why riskier portfolios aren't advised for older people closer to or within retirement age, the obvious complementary group being younger people who could lose more with lesser permanent consequence.

Your high risk investment choices have nothing to do with your ability to manage other people's money, unless you fail to make a noteworthy investment return, then your high risk approach will be the death knell to your fund managing aspirations.

Answer 5

I'm going to diverge from most of the opinions expressed here.

It is common for financial advisors to assume that your portfolio should become less risky as you get older. Explanations for this involve hand-waving and saying that you can afford to lose money when young because you have time to make up for it later.

However, the idea that portfolios should become less risky as you get older is not well-grounded in finance theory. According to finance theory, regardless of your age and wealth, returns are desirable and risk is undesirable. Your risk aversion is the only factor that should decide how much risk you put in your portfolio.

Do people become more risk averse as they get older? Sometimes. Not always. In fact, there are theoretical reasons why people might want more aggressive portfolios as they age. For example:

1. As people become wealthier they generally become less risk averse. Young people are not normally very wealthy.

2. When you are young, most of your wealth is tied up in the value of your human capital. This wealth shifts into your portfolio as you age. Depending on your field, human capital can be extremely risky--much riskier than the market. Therefore to maintain anything like a constant risk profile over your life, you may want very safe investments when young. You mention being a hedge fund manager. If we enter a recession, your human capital will take a huge hit because you will have a hard time raising money or getting/keeping a job. No one will value your skills and your future career prospects will fall. You will not want the double whammy of large losses in your portfolio. Hedge fund managers are clear examples of people who will want a very safe personal portfolio during their early working years and may be willing to invest very aggressively in their later working and early retirement years.

In short, the received wisdom that portfolios should start out risky and get safer as we age is not always, and perhaps not even usually, true. A better guide to how much risk you should have in your portfolio is how you respond to questions that directly measure your risk aversion. This questions ask things like how much you would pay to avoid the possibility of a 20% loss in your portfolio with a certain probability.

Answer 6

There is no rule-of-thumb that fits every person and every situation. However, the reasons why this advice is generally applicable to most people are simple.

Why it is good to be more aggressive when you are young

The stock market has historically gone up, on average, over the long term. However, on its way up, it has ups and downs. If you won't need your investment returns for many years to come, you can afford to put a large portion of your investment into the volatile stock market, because you have plenty of time for the market to recover from temporary downturns.

Why it is good to be more conservative when you are older

Over a short-term period, there is no certainty that the stock market will go up. When you are in retirement, most people withdraw/sell their investments for income. (And once you reach a certain age, you are required to withdraw some of your retirement savings.) If the market is in a temporary downturn, you would be forced to "sell low," losing a significant portion of your investment.

Exceptions

Of course, there are exceptions to these guidelines. If you are a young person who can't help but watch your investments closely and gets depressed when seeing the value go down during a market downturn, perhaps you should move some of your investment out of stocks. It will cost you money in the long term, but may help you sleep at night.

If you are retired, but have more saved than you could possibly need, you can afford to risk more in the stock market. On average, you'll come out ahead, and if a downturn happens when you need to sell, it won't affect your overall situation much.

Answer 7

Would my high-risk investment choices, aside from the main question, have any bearing on the road I want to go down and test (managing mutual/hedge funds)?

Absolutely! First of all, understand that hedge fund managers are managing other people's money. Those people desire a certain risk profile and expected return, so your hedge fund will need to meet those expectations. Plus, hedge fund managers don't typically get fixed fees alone - they also get a percentage of any gains the fund makes; so managers have a vested interest in making sure that hedge funds perform well.