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July 22, 2005 at 08:00 PM
Like the rest of the developed world, the U.S. faces some dramatic changes in demography, which may drastically impact the government’s budget, the fate of retirement assets, and the performance of financial markets, including the behavior of the investment community.
These demographic shifts center on the aging and imminent retirement of the so-called “Baby Boom” generation, those roughly 80 million Americans who were born between 1946 and 1964. As the baby boomers enter their twilight years, the next group coming up, “Generation X” — about 75 million Americans born between 1961 and 1981 — may be unwilling or unable to support the immense financial and health care needs of their elders.
A rapidly aging population, combined with a falling number of active workers, would represent an unprecedented tandem in U.S. history, and could significantly change the way we invest and what we invest in. Doomsayers have forecasted that this confluence of events could bankrupt Social Security and exhaust Medicare and Medicaid long before the middle of the century.
In essence, because of low birth rates and longer life expectancies, the developed world is getting older faster, and the number of workers required to support the their retired elders is shrinking.
According to the Center for Strategic and International Studies (CSIS), a Washington D.C.-based research firm, about 20% of the current population in developed countries is aged 60 or older. By 2040, that figure will rise to 35%. In fact, in the fastest-aging nations like Japan, Spain and Italy, the percentage of elderly people will approach an astounding 50%. Indeed, some observers have speculated that the economic malaise gripping once-powerful nations like Japan and Germany is directly tied to their rapidly aging populations, and the enormous social services and medical care they require, most of which is provided by a dwindling workforce and high taxes.
The U.S. actually has the most favorable demographic profile among the developed world: About 16.3% of the population is elderly now, and that figure is expected to project to 26.0% in forty years. The birth and immigration rates in the U.S. will likely ensure the country will not suffer negative population growth. Indeed, the working-age population is already shrinking in Japan and southern Europe.
Still, the potentially large numbers of retirees will impose a heavy burden on the U.S. economy, taxpayers, the heath care system, and the sustainability of today’s retirement programs. The CSIS estimates that by 2040, public benefits (including pensions, health care benefits and unemployment insurance) to the elderly in the developed world will reach 25% of GDP, or about double today’s levels. For the U.S., these figures amount to 9.4% and 20.3%, respectively.
Neil Howe, an economist and author who has written extensively about future demographics, said that baby boomers are entering their peak earnings years, and that this is largely driving the economy. “After the oldest Boomers become eligible to retire on Social Security in 2008, a steadily growing share of this large generation will be selling assets and consuming less,” he said. “This could spell trouble for the stock market and the economy. A smaller and more income-strapped Generation X may not be able to pick up the slack.”
What do these bleak forecasts mean for stock investors and mutual funds themselves? Do they present opportunity, or reasons for long-term pessimism?
It is impossible to say, since mutual fund managers and market participants cannot invest with a multi-decade perspective. Indeed, most average investors don’t look beyond the next year or so for their portfolios.
“The impact on mutual fund investing will probably not be as severe as other prognosticators are warning,” said Louis Harvey, president of Dalbar Inc., a Boston-based mutual fund consultant. “When the baby boomers reach retirement, the assumption is they will sit in a rocking chair and smoke a pipe. But the fact is, people in retirement are beginning new careers. I see a regeneration and a reentry into the workforce of these ‘retired’ folks, which gives them another 25 years in the labor force. The impact on investing is that we won’t see a sudden shift from accumulation to withdrawal; rather, we’ll likely see a gradual shift, a stabilization. Most retirees will keep their money in the market in one form or another.”
However, Harvey cautions that “mutual funds became an investment for ordinary people only in the 1980s, so we don’t really have enough history to make any determinations on future fund investor behavior.”
In many cases, retirement is being postponed, people are living and working longer, says Charlie Mayer, Director of U.S. Portfolio Management at Pioneer Investment Management Inc. “With tax laws changing and interest rates so low, many older investors could substitute equities for conservative bonds in their retirement portfolios,” he said. “Baby boomers, in particular, have to not only take care of their children, but also their parents. But it’s up to each individual’s own risk profile to see how they can cope with retirement.”
Howe strikes a more admonitory tone. “Baby boomers are worried that there will not be enough Social Security for them; and are worried about their overall financial security,” he said. “They are uniquely lacking of confidence regarding their retirement. Boomers have trouble getting beyond their early expectations that ‘the system’ would somehow always take care of them. They had hoped they wouldn’t really have to take personal responsibility.”
On the other hand, Howe points out, Generation X seems to have more confidence in their future retirements and financial health. “Gen-X never trusted the system, and they know it won’t be there for them,” he noted. “As such, they’re making alternative arrangements for their futures”
