Can Young Investors Take On More Risk?

Investors ask, “I am retiring soon and want to know if I should sell all my stocks and hold onto cash instead of investing?” This is an excellent question. The classic investment industry answer would be something like “buy and hold”, or “if you are young you can afford the risks of stocks so hold on for the long run because eventually the market will go back up.” I am opposed to those cliché answers.

If the market is overpriced then no one, old or young, should accept the risks of a crash and so they should get out of the market. The idea that it is OK for a young person to hold on to risky stocks during a bubble because he will have a long time to rebuild his net worth after a crash is wrong. Instead, if you detect the risk of a crash then get out and wait until a good buying opportunity to get back in. The idea of a young person saying it is OK to take excessive risk in stocks because they are young is no more of a sound idea than saying it is OK for young people to incur risk from taking illegal narcotics because they are young they will have years ahead of them to get rehabilitated. That is wrong. If something is unsound then don’t do it!

The sound method of investing is to buy when PE ratios using a ten year inflation adjusted average are low; this must be coupled with examining the financial health of a company in terms of things like low debt loads, high percentage ROE, reliably growing revenue, a corporate moat, etc.

The ten year PE of the market is about 23 and normally it should be about 15 to 17 depending on which metrics you trust. To be a good investor you need to wait until the PE is below 15 to buy at a discount below fair value. This implies that the market needs to drop about a third to be fairly valued or else corporate earnings need to increase during a recession. I don’t think corporate earnings will increase until consumers have fixed their debt loads and increased their jobs skills and get better jobs. That may take, on average, seven years, according to Reinhardt and Rogoff, to go through a deleveraging process of reducing debts. Very little progress on deleveraging has been done, except for those who went into foreclosure.

About the author

Don Martin, CFP®

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