This morning the Wall Street Journal ran a story which showed that 2013 was the first year in decades that there was a net outflow from 401(k) plans. The immediate reaction by many was that this is just the start of a mass exodus from the markets by retiring baby boomers, which could have huge implications on the markets in the coming years as we patiently wait for Millennials to pick up the slack with their savings in the 2020s.
A few thoughts I had off the top of my head after reading this piece:
- It’s likely the majority of these outflows are just being rolled over into IRAs to simplify and aggregate retiree portfolios and not money being taken out of the markets completely. This trend will continue for a number of years.
- Something like 85% of the wealth in this country is held by 20% of the people. It’s not all going to come out at once and much of this wealth will be passed on to the next generation.
- This will be a drawn out process. Life expectancy continues to climb. Retirees will still need to invest a portion of their portfolios in stocks for growth.
- Although U.S. stocks make up half of the world’s market capitalization, you can’t think locally anymore in a world made up of global markets and economies. There will be plenty of foreign investors and opportunities in global markets in the coming years and decades. The U.S. was once an emerging market, too.
In his book Irrational Exuberance, Robert Shiller took a look at the data on this topic and came to the following conclusion:
If life-cycle savings patterns (the first effect) alone were to be the dominant force in the markets for savings vehicles, there would tend to be strong correlations in price behavior across alternative asset classes, and strong correlations over time between asset prices and demographics. When the most numerous generation feels they need to save, they would tend to bid up all savings vehicles: stocks, bonds, and real estate. When the most numerous generation feels they need to draw down their savings, their selling would tend to force down the prices of all these vehicles. But when one looks at long-term data on stocks, bonds, and real estate, one finds that there has in fact been relatively little relation between their real values.
Shiller doesn’t completely deny that there were effects from the baby boomer demographic wave, but he thinks the investing public’s perception of the demographic effects probably had more to do with the 80s and 90s bull market than the actual demographics behind it. In the markets, perception is often reality so I don’t think that you can completely ignore the demographic implications on the markets.
One of the things I’ve learned over the years is that demographics play a huge role in shaping the economic landscape from everything to the unemployment and labor force participation rates to the buying habits in the real estate market to economic growth (see Calculated Risk on why 2% growth is the new 4% growth for more on this). People are quick to blame or shower praise on politicians when it comes to the booms and busts we see in the economy. More often than not, the economic success or failure of those politicians has more to do with lucky timing in regards to where we happen to be in the economic (or demographic) cycle.
So while demographics does play a large role in shaping economic growth, it’s difficult to say how the mass exodus from the workforce by baby boomers is going to affect the financial markets. It probably comes down to investor behavior more than anything. It’s fairly easy for models to predict how the demographics will play out in the U.S. and abroad in the coming years. It’s not so easy to model out how investors will react to those changing demographic profiles.
Life Expectancy & Longevity Risk
Money Flows Out of 401(k) Plans as Baby Boomers Age (WSJ)
I am a naive gen-Xer. I believe that this baby boomer demographic transition will probably keep the valuations of dividend aristocrat stocks at current levels for the foreseeable future, as boomers follow model portfolio allocations and remain invested in conservative blue chips. I think buying and holding Vanguard’s VIG etf will outperform over the next decade.
Could be. The chase for yield could last much longer than most people assume. Rising rates are a threat but I get the sense that many will bail out of bonds once interest rates start to rise and principal losses kick in. It’s going to be an interesting environment to invest in (although I guess that’s always the case).
One thing to remember is that these accumulated assets represent deferred compensation. If you make the link between stock prices and expenditures (that is, stock prices reflect the revenues that consumer expenditures generate), then you can take the next logical step: That is, all of this accumulated investment (deferred consumption) once converted to current consumption will translate into revenue for listed equities and thus support for stock prices.
Well said. It’s funny that more people don’t realize that saving and investing is really just future consumption. It’s impossible to look at one side without seeing the checks and balances elsewhere. Great point.
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Harry Dent was totally wrong abut his boomer assumptions as well as others who feel the market will suffer as boomers age. As you said, longevity has increased now so boomers need stocks to survive 20-30 more years. Especially now that pensions are few and far between. Add in low interest rates and that intensifies the need for growth from equities. Future income will now come from total return, instead of just dividends and bond yields. Manufacture your own dividends from long term capital gains, and an added benefit is these are usually taxed lower than interest and dividends. And high dividend stocks are cyclical, just like other categories of equities so they will not be the best place for yield forever. Many cut dividends in tough times, and many have low total return.
I think Dent actually tried to create a demographic-based ETF and it obviously failed. He’s had a tough run of terrible predictions. I agree that it’s counterintuitive, but many boomers will actually be boosting equity exposure or keeping it constant because they need the growth. There are many factors to consider here.
I saw a TV interview a couple of years ago where someone was asked how the stock market can keep growing at 7% / year when the economy is growing 2 – 3% / year. The answer was that some stock investors need to sell their assets to get spending money. They stop getting that compounding growth. That means more of it flows to other investors who stay in the market.
Where you look at it that way or in terms of assets chasing yield, there are a lot of long-term positives. The short term is more uncertain.
If there really have been simultaneous trends of boomers investing a lot and the stock market delivering high returns, they could have a pretty good spending power even after retirement. Combined with higher levels of health at old ages, they may be spending a lot more than previous retirees.
That sounds like it would boost markets in the short term while shifting ownership towards younger workers who have a longer time to plan for. I don’t know if that’s what will happen but I don’t worry about it.
You also have to remember that publicly traded stocks don’t make up the entirety of the economic growth engine so there are a lot of other moving parts to consider than GDP. It’s possible that boomers will spend more than previous generations but remember that means more growth in the economy so there are checks and balances in place. Should be interesting…
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