The idea that the baby boomers — who began retiring in droves in 2011 — will eventually crash the stock market has been going around for years. But will it actually happen?
Cathy Pareto, president of Cathy Pareto & Associates, a wealth management firm in Miami, Fla., believes the idea is farfetched because people who retire don’t just yank all of their assets out of the market at once. They gradually shift their retirement assets from higher risk equities to lower risk bonds and stable value funds as they age, she said.
“You don’t plan for retirement the day before or the day after you retire,” she said. “Most have moved out of the stock market and already are invested in bonds, so the premise of this idea that all of these people are moving out of the stock market at once is flawed. They can’t afford to do that.”
Another reason Pareto doesn’t believe the boomers will crash the market is that Treasury bond yields are very depressed. The current yield is less than 2 percent, “so retirees can’t afford to live on those types of yields,” Pareto said. “If you look at the S&P 500, the dividend is just above 2 percent. Granted, you take a different kind of risk to get that kind of income, but retirees would be hard pressed to make any reasonable money in just bonds in this environment.”
The baby boomer generation encompasses 78 million people who were born between 1946 and 1964, according to the Congressional Budget Office in its report, “Will the Demand for Assets Fall When the Baby boomers Retire?”
“Some economists warn that if the baby-boom generation begins to sell off assets to finance retirement, there could be a steep decline in the demand for assets, particularly stocks,” the 2009 report found.
Some economists concluded that the increase in baby boomers’ demand for assets during their high-saving years is what caused the stock market to be so strong over the past two decades.
“In principle, if such an unusually large cohort were to sell its accumulated assets to finance consumption during retirement, the total demand for assets in the economy could fall substantially over several decades and the prices of those assets could decline as well,” according to the CBO. “However, empirical evidence about the behavior of earlier groups of retirees suggests that baby boomers will not sell their accumulated assets quickly after they retire.”
Evidence from past groups of retirees shows that most people don’t substantially change the composition of their asset portfolios upon retirement, the report found.
The recession has caused many people to defer their retirement to a later date, which would reduce the amount of assets they would need to sell off to finance their retirement lifestyle. “The aggregate effect on asset demand might be small, however, if people delayed retiring for only a year or two,” the report found.
The CBO added that foreign demand for U.S. assets should help counterbalance the baby boomer exodus.
The Federal Reserve Bank of San Francisco attempted to tie demographic trends to stock prices in its August 2011 report, “Boomer Retirement: Headwinds for U.S. Equity Markets?”
“Many baby boomers have already diversified their asset portfolios in preparation for retirement,” the report stated. “Still, it is disconcerting that the retirement of the baby boom generation, which has long been expected to place downward pressure on U.S. equity values, is beginning in earnest just as the stock market is recovering from the recent financial crisis, potentially slowing down the pace of that recovery.”
The Federal Reserve Bank used a statistical model in which the equity price/earnings (P/E) ratio depends on a measure of age distribution. It constructed its P/E ratio based on the year-end level of the Standard & Poor’s 500 Index adjusted for inflation and average inflation-adjusted earnings over the past 12 months. It also measured age distribution using the ratio of the middle-age cohort, age 40-49, to the old-age cohort, age 60-69. It referred to this as the M/O ratio.
“In our view, the saving and investment behavior of the old-age cohort is more relevant for asset prices than the behavior of young adults. Equity accumulation by young adults is low. To the extent they save, it is primarily for housing rather than for investment in the stock market. In contrast, individuals age 60-69 may shift their portfolios as their financial needs and attitudes toward risk change,” the report found. Social Security benefits also help determine how people react to retirement saving as they age.
According to its data, the Federal Reserve Bank found a high correlation between the P/E and M/O ratios between 1954 and 2010. For example, between 1981 and 2000, baby boomers reached their peak working and saving ages and the M/O ratio increased from about 0.18 to about 0.74. During the same period, the P/E ratio tripled from about 8 to 24.
In the 2000s, as the baby boomers began to age, both the M/O and P/E ratios declined substantially.
“Despite theoretical ambiguities, U.S. equity values have been closely related to demographic trends in the past half century. There has been a tight correlation between population dependency ratios, such as the M/O ratio, and the P/E ratio of the U.S. stock markets,” the report concluded. “In the context of the impending retirement of baby boomers over the next two decades, this correlation portends poorly for equity values.”
Market participants may assume the markets will react badly to the retirement of the baby boomers, which also could have a negative impact on the stock market in the future.
“It’s hard to keep emotions in check when it comes to money issues,” Pareto said. “Emotions get you in trouble. You let your fears take over logical decision-making. That is classical behavioral finance. You can look at numbers all day, strip things apart numberwise, but you have this other nontangible force out there which is people’s behavior, which is directly tied to emotions. It is not so black and white.”
She added that she is more concerned about the baby boomers’ effect on health care and the drain on entitlement programs than their effect on financial markets.
For more Boomer coverage, see: