The Real Reason Young People Should Invest Heavily in Stocks

It's not the reason you think it is

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Here’s what might be the most widely accepted investing advice ever to exist:

Young people should invest more heavily in stocks than older people.

It’s the kind of milquetoast statement you’ll see investing gurus on Twitter make as if they just cracked the secrets of the universe.

As milquetoasty as that statement is, it’s also true. Young people should be investing more in stocks. Some academic economists suggest that it even makes sense for young people to use leverage (borrow money) to invest in stocks.

The question so few people ask about investing

Most of us agree younger investors should invest more in risky investments like stocks than older people. But here’s the question I wish people asked more often:

Why is it that young people should invest heavily in stocks? Most financial advisors would say it’s because they have more years until retirement, which gives their investments a longer time to recover from a potential market crash in the future.

While I don’t disagree with this argument, it doesn’t fully answer the question. It doesn’t explain why academic economists would draw up a model suggesting young people should borrow money to invest.

(Side note: borrowing money to invest in stocks usually ends in disaster, I wrote more about why here.)

The young have what the old want… and Vice versa

I will do my best to keep this short, informative, and fun but be wanted; I’m about to geek out on some economics stuff.

Back to the central question, why should young people load up on stocks, and why should older people de-risk.

The answer is because both young and old likely have a similar amount of wealth, just in radically different forms.

The old are rich in financial capital. After a lifetime of saving and investing, people in their 60s and 70s tend to be flush with cash, stocks, bonds, and real estate.

The young are rich in human capital. Your human capital is your ability to earn a paycheck. The more paychecks you have left to collect in your life, the more human capital you own.

If you’re 25 and plan on working until 65, you have as many as 1,040 paychecks left to collect in your life. These paychecks you have yet to collect are nothing but a stream of future cash flows. Like any stream of future cash flows, econ and finance nerds can put a present value on them. If you have 40-years of future cash flows to collect, the present value is probably as big as your parent’s 401k + the value of their house.

If you have a 9-5 job, the paychecks you collect look a lot like coupon payments from a bond. Every two weeks, the same amount of money hits your bank account like clockwork, just like a bond.

So, here is the answer to the question we’ve been circling.

Young people should load up on stocks because they are potentially sitting on millions of dollars worth of “bond-like” human capital. In comparison, they probably have very little risky financial capital like stocks.

Young people need to over invest in stocks because they already have way too much bonds in their portfolio of human capital.

Retirees have the opposite problem.

Retirees could be sitting on millions in financial capital, but if they stopped working, their human capital is worth $0. That means to properly diversify their portfolio of financial capital; they should be de-risking and investing more in bonds.

The cruel irony is that each wants what the other has.

The struggling young person looks at the retired boomer sitting on millions with envy not knowing that the retiree would gladly trade in every penny they have to be 25 years old again.

TLDR

The young should invest heavily in stocks because they are sitting on millions in bond-like human capital. While the old have depleted their human capital and only have their financial capital to rely on, which means it needs to be balanced between stocks and bonds.

In either case, the answer comes down to having a well-balanced portfolio.

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This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.