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The New Normal for Young Investors

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It's no secret that investors have responded en masse to the recent financial crisis by fleeing stocks. Billions of dollars have flowed out of stocks and stock mutual funds and into the safe haven of bonds. And while it is understandable that older investors and folks near retirement may want to take portfolio risk down a notch, it looks like the stock-shunning trend is not limited to the older generation.

Playing it safe
According to a recent survey from the Investment Company Institute, only 22% of investors under the age of 35 are willing to take on a substantial amount of risk in the market. Likewise, a separate Merrill Lynch survey of affluent investors showed that 56% of young investors consider themselves to be more conservative today than they were a year ago -- and that 56% is the highest percentage among all age groups. Apparently, the recent financial crisis has left a lasting impression on our country's youth and may affect their financial behavior for years to come.

Of course, some of this pessimism may fade once the economy makes a fuller recovery, but there's a good chance some of the psychological damage inflicted on this younger generation may be long-lasting. After all, they've lived through some financial events that were pretty unthinkable just a few years ago -- the failure of Lehman Brothers, the near-destruction of big-name banks such as Citigroup and Bank of America, and the complete crumbling of mortgage giants Fannie Mae and Freddie Mac. Just as the views and investing habits of those who lived through the Great Depression decades ago were forever altered by that experience, today's young investors may also maintain some of their wariness toward stock market investing.

Long-term thinking
Unfortunately, this newfound reluctance to take on risk is likely to hurt 20- and 30-somethings in the long run. While the urge to hide in the safety of bonds is appealing, the fact of the matter is that younger investors simply won't be able to save enough to fund an adequate retirement if stocks aren't a large part of the equation. Even if we ignore the fact that bonds are likely at the tail end of a bull run and that rates are almost certain to rise as soon as next year, historically, bonds simply haven't produced the kind of long-term results that stocks have.

From 1928 to 2009, stock prices rose at an average growth rate of 9.3%, whereas bonds clocked in with a 5% gain. Even if we exclude older time periods, from 1960-2009, stocks measured up with 9.4% compared to 6.6% for bonds. Of course, that relationship has been the exact opposite in the past decade, with bonds taking the cake with a 6.3% average return and stocks falling 0.1%.

To me, these recent numbers don't speak to a shrinking equity premium for stocks, but rather an outlook for the future in which stocks are very likely to outperform bonds. Consider that the last decade has contained two very painful bear markets, so investors can't necessarily consider this time period as indicative of the future. Given that stocks have underperformed so pitifully, odds are good that the next decade will see the performance advantage shift back in favor of stocks.

To be clear, I do think the current economic recovery will be extremely slow and painful. It will take years for unemployment to be brought back down to pre-recession levels, and there are many excesses that still need to be drained out of our system. The next few years aren't likely to be stellar ones for stocks, but for young investors with 25 or 30 years left in their career, their focus shouldn't be on what the market does in the next three to five years, but what it does over the next several decades. And by shunning stocks now, they are putting their retirement dreams and other financial goals at risk.

Getting back in the game
If you're among the younger generation (or even if you're just young at heart!) and are wary about stepping back into the stock market, try taking some baby steps to start positioning your portfolio for longer-term gains. A good place to start may be with a low-cost, well-diversified exchange-traded fund like the SPDR S&P 500 (NYSE: SPY  ) or the Vanguard Total Stock Market ETF (NYSE: VTI  ) . These funds will give you wide exposure to the market at a very low price (0.09% for the SPDR and 0.07% for the Vanguard fund).

Once you've got a good base established for your broad market exposure, you might want to consider moving into individual stocks. Right now, dividend-producing names are gaining popularity among folks who haven't been scared away from the market. Given that economic and market conditions are likely to remain challenging, investors should welcome stocks that provide a little boost via a dividend payment.Johnson & Johnson (NYSE: JNJ  ) is trading at less than 13 times its earnings while also boasting a 3.6% dividend yield. Likewise, ExxonMobil (NYSE: XOM  ) sports a 2.9% yield while trading at a P/E ratio less than 12. Both names should be relatively steady performers and reliable dividend payers for investors young and old.

Time will tell whether today's youngsters retain their distaste for risk and for stock investing. Hopefully, for the sake of their retirement and future financial goals, they will overcome their fears and get back on track before it's too late.

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Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement investment newsletter. At the time of publication, she did not own any of the funds or companies mentioned herein. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson, which is a Motley Fool Income Investor recommendation. The Fool owns shares of ExxonMobil. Try any of our Foolish newsletter services free for 30 days.The Motley Fool has a disclosure policy.


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Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement investment newsletter.

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