Formative experiences and their impact on financial behavior

Peeling the onion

Scars from economic and financial distress can run deep. What enduring effects will the scars of the past decade have on people’s behavior, particularly their financial behavior?

June 14, 2017

A blog post by Urval Goradia, senior market insights analyst, Deloitte Services, LP

As you probably recall, a decade ago, the first flickers of the financial crisis became visible to the world. And, a year later, the global financial system teetered on the brink, with dire consequences for average Americans. Almost one in six American workers lost jobs during the 2007-09 Great Recession.1 Over a third of workers reported anxiety over layoffs, wage cuts, shorter hours, and trouble finding work applicable to their skill levels.2 Also, a vast majority of investors lost money due to the precipitous decline in the stock market.3 Similarly in Europe, amid fledgling recovery, sovereign debt crises of the Euro area periphery left several nations with record levels of unemployment (especially among 18-to-25 year-olds).

Scars from economic and financial distress can run deep. Take, for instance, the experiences of the people who lived through the Great Depression. Stories of their frugality and aversion to risk decades into financial stability have become common lore for many of us, who know them as relatives and friends.

Likewise, even with stock markets near record highs and today’s relatively upbeat economic sentiment, it behooves us to ask: What enduring effects will the scars of the past decade have on people’s behavior, particularly their financial behavior?

A recent paper in the Journal of Finance examining the associations between formative experiences (such as a job loss) and future portfolio choices yields some insight. By analyzing data from the 1991-93 “Finnish Great Depression”—when Finland’s GDP contracted by 10 percent and unemployment skyrocketed from 3 percent to 16 percent—researchers show that individuals negatively affected by adverse labor markets are less likely to invest in risky assets.4

The researchers measured that stock market participation, a full decade after the depression, was 2.8 to 3.6 percent lower for affected workers. As the authors observe, these effects are fairly large, as the stock market participation rate in the Finnish sample was 22 percent. Of equal importance, those who underwent the shock second-hand—as family members or neighbors of affected workers—also turned more risk-averse. Stock market participation was 0.4 to 0.6 percent lower among these groups.

Considering the severity of unemployment that accompanied the financial crisis in the United States and other crises worldwide, these findings portend that a broad cross-section of households might have become more risk-averse. The following observation is notable in this context: A recent Gallup survey showed that stock market participation among US adults dropped from 65 percent in 2007 to 54 percent in April 2017.5

Other research outside the United States also bears this out: There was “a loss of trust in financial intermediation prompting some investors to abandon the stock market altogether and the remaining investors to take on more idiosyncratic risk, on average [in Germany even three to four years after the financial crisis.]”6

Why should financial services firms care about formative experiences?

First, there is a lot at stake. The financial assets of US households are projected to grow to $64 trillion by 2030.7 Many households are now led by Millennials, who were in their formative years of consumerism and career development when the financial crisis hit. We can safely assume that in dollar terms a sizable piece of these trillions of household financial assets are held by Millennial households.

It simply makes sense, in a digital world in which consumer data is deep and widespread, to understand how customer preferences for asset classes have been moving since crises of any size. Of course, there is the need to design financial products and services in line with customer professed attitudes.

However, firms should not only look at what customers are saying but also pay attention to why they are saying so. It behooves firms to learn more about the link between macroeconomic setbacks, formative experiences, and risk aversion that stretches sometimes even illogically into periods of financial growth or stability. For one, we know that this behavior can be remarkably durable; attitudes toward risk even traverse generations, from parents to their children.8

Second, findings point to a psychological factor about risk-aversion and macroeconomic setbacks. Clients who have experienced them in formative stages of their consumer development may not even actively acknowledge their own reactive financial behavior responses. Deeper probing through risk tolerance questionnaires that inquire about significant financial experiences could unearth valuable detail. These types of studies can help financial advisors drive more informed conversations, offer better product recommendations, and ultimately create stronger relationships with clients, practitioners, and financial institutions.

Building on the last point, financial firms should also consider explicitly addressing formative experiences in the way that they educate customers. Formative financial experiences influence a wide spectrum of financial behaviors. Levels of returns experienced on stocks and bonds affect the future likelihood of owning these assets, with more recent experiences demonstrating stronger effects.Similarly, consumers’ inflation expectations are strongly informed by the inflation they have experienced in their lifetime, and these expectations even explain certain household borrowing and lending behavior.10 By educating clients about a broader spectrum of financial experiences, firms can truly bring the common refrain “Past performance is not indicative of future results,” to life.

The complexity underlying our choices makes it is impossible to gain a full picture of how economic experiences affect customer behaviors and choices. Nonetheless, it is beneficial and even incumbent on financial firms and professionals to understand their clients’ formative experiences and ask how they might influence their risk appetite.

It behooves firms to learn more about the link between macroeconomic setbacks, formative experiences, and risk aversion that stretches sometimes even illogically into periods of financial growth or stability.

1 Henry S. Farber, “Job Loss in the Great Recession: Historical Perspective from the Displaced Workers Survey, 1984-2010,” NBER Working Paper No. 17040, Issued in May 2011
2 Steven Davis and Till von Wachter, “Recessions and the Costs of Job Loss,” Brookings Papers on Economic Activity, Fall 2011
3 Employee Benefit Research Institute, “The Impact of the Recent Financial Crisis on 401(k) Account Balances,” EBRI Issue Brief #326, February 2009
4 Samuli Knupfer, Elias Rantapuska, and Matti Sarvimaki, “Formative Experiences and Portfolio Choice: Evidence from the Finnish Great Depression,” Journal of Finance, February 2017
5 Gallup poll on the Stock Market,
6 Daniel Dorn and Martin Weber, “Individual Investors’ Trading in Times of Crisis: Going It Alone or Giving Up?,´
7 Val Srinivas and Urval Goradia, “The future of wealth in the United States: Mapping trends in generational wealth,” Deloitte Insights, November 9, 2015
8 Thomas Dohmen, Armin Falk et al, “The Intergenerational Transmission of Risk and Trust Attitudes,” The Review of Economic Studies, November 2011
9 Ulrike Malmendier and Stefan Nagel, “Depression Babies: Do Macroeconomic Experiences Affect Risk Taking?” The Quarterly Journal of Economics, February 2011
10 Ulrike Malmendier and Stefan Nagel, “Learning from Inflation Experiences,” The Quarterly Journal of Economics, October 2015

QuickLook is a weekly blog from the Deloitte Center for Financial Services about technology, innovation, growth, regulation, and other challenges facing the industry. The opinions expressed in QuickLook are those of the authors and do not necessarily reflect the views of Deloitte.

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