Investor Behavior: The Psychology of Financial Planning and Investing

CHAPTER 24

Post-Crisis Investor Behavior: Experience Matters

Joseph V. Rizzi

President, Macro Strategies, LLC

INTRODUCTION

The initial impact of the financial crisis of 2008 on investors was substantial. A panic induced a shift away from risky assets (e.g., common stocks) toward safer, more liquid investments (e.g., government bonds). The recovering economy and improved financial markets may trigger a return to pre-crisis risk appetite and investments. Nonetheless, current investor behavior suggests otherwise, especially for certain age groups (Zick, Mayer, and Giaubitz 2012).

A disagreement exists about the longer-term impact of the financial crisis on investor expectations, especially investor willingness to invest in the stock market. Traditional finance theory suggests investor experiences are irrelevant. All that matters are asset market fundamentals. Furthermore, investor risk tolerances are stable. Behavioral finance and recent evidence imply otherwise (Malmendier and Nagel 2011). Macroeconomic experiences can affect investors' expectations and willingness to invest in the stock market as risk tolerances are time varying.

Nonetheless, questions remain, such as whether investors weigh all experiences equally and whether they give greater weight to recent experiences or early formative experiences. The answer to these questions has important implications for asset allocation decisions, the equity risk premium, and longer term investor behavior.

This chapter begins with a ...