Generation Yikes: Why young savers are avoiding stocks

Ask any money manager about people who don't invest in stocks, and the answer is probably a little condescending. They just don't understand the market; they're not thinking about the long-term; they're unsophisticated, preferring to stick their money under a mattress.

But Diane Casaretti is no rube. She's a successful marketing rep in Stamford, Connecticut, and in her career has worked with many Wall Street banks and brokerage houses. But she's made a conscious, rational decision: Stocks just aren't for her.

"My parents always invested their money in the stock market, and all my friends' families did too," says the 26-year-old. "When the whole thing came crashing down with the financial crisis, that's when I said, 'No way am I comfortable with this.' To me it just doesn't seem logical, that you could save all that money and then potentially lose it all down the road."

It's a refrain that you're hearing more and more these days - and not from risk-averse seniors, as you might expect, but from those just starting out in their working and investing lives. Even with decades to go until retirement, and plenty of time to rebound from market collapses, many young Americans don't trust the stock market with their savings.

Take a recent Investing Sentiment Survey by Boston-based money managers MFS Investment Management. The poll discovered that 29% of people say they will never be comfortable investing in stocks - a shocking number in and of itself. But among Generation Y investors under 31, that number spikes to 52%.

If that sentiment holds, it means that a large chunk of an entire generation of investors could be shunning equities for years to come. And that's not exactly a tailwind for the Dow. "Those numbers are surprising to us, but you can't really blame them," says William Finnegan, MFS' senior managing director. "Younger folks are essentially saying that the market is a very scary place - and as a result, a lot of their money is just being held in cash."

Like Diane Casaretti, whose savings are sitting in a bank account earning around 1%. She's so freaked out by the wild market ride of the last few years that she never even set up her 401(k), with its promise of a company match.

That jibes with the MFS survey, which asked investors which asset classes they would deem an "excellent or very good place to invest." The only area on the rise: Safe harbors like bank CDs, savings accounts and money markets. As for stocks, from February to October of last year, that number was sliced in half: Only 18% of Americans now see equities as a very good place to put their money.

Judging from fund flows, that dire sentiment is having very real effects on asset allocation. Retail investors pulled almost USD 37 billion from stock funds in 2010, and more than USD 101 billion over the first 11 months of 2011, according to the Investment Company Institute.

In such numbers we may be witnessing the deep psychological damage the recession has wrought, MFS' Finnegan notes. "It's much like during the Great Depression, when the people who came through that became very conservative," he says. "It looks as though the new wave of younger investors is very conservative, and only comfortable with bank products. I don't think that changes in the short-term."

Of course, retirement prospects for Generation Y don't look very glamorous when their savings aren't even keeping up with inflation. Keeping savings in cash at a young age isn't going to help fund luxurious retirements. But given the power of compounding, an early aversion to stocks could prove especially harmful. According to data from Baltimore-based fund shop T. Rowe Price, if one saver puts away USD 500 a month from ages 21 to 30 and enjoys a 7% annual return, she will end up with almost a million bucks at age 65. That handily beats another saver who waits for that level of return until age 31 yet contributes all the way to 65, despite putting up USD 150,000 more than the first investor.

There is one bright spot for equities: The 401(k) plan. Despite the profound gloominess expressed in sentiment surveys, mutual-fund giant Vanguard Group notes that investors in its retirement accounts actually boosted their stock allocation in 2010, to 70 percent - up 2 percent over the previous year. That's in part thanks to industry trends like auto-enrollment, designed to hike plan participation rates. New investors are sometimes automatically slotted into target-date funds, which feature high doses of equities for younger investors.