Aging population has implications
There has been a lot written on the issue of demographics and how that might influence prices of financial assets going forward. From people like David Foot, Harry Dent, and Bill Sterling, demographics has become a popular topic and something of a buzzword - to the extent that many mutual funds incorporated it into their strategies and names. Recent research into demographic trends reveals some thought provoking conclusions.
Robert Arnott (chairman of First Quadrant LP) and Anne Casscells (managing director at Aetos Capital LLC) published a research paper on this very topic in the March/April 2003 issue of the Financial Analysts Journal, published by the Association for Investment Management and Research (AIMR) entitled "Demographics and Capital Market Returns".
The U.S. (and by extension, North American) population is aging. In the 1940s, working people (mostly men) rarely lived to age 65. In 2000, the average person lived past the age of 76. This, combined with what the authors call lower "fertility rates" (i.e. percentage of births per woman of child-bearing age), has combined for a population with a rising median age. And this trend is expected to continue.
Not only will the average age rise, but also the ratio of working people to retirees, and to dependents (i.e. retirees and children). The ratio of working people to retirees (i.e. over 65) was 7.3 in 1950. That ratio is 4.7 today and is expected to fall to 2.7 by the year 2035.
The most obvious implication of having fewer workers per retiree is that government pensions, which are funded on a "pay-as-you-go" basis, will have to consistently raise premiums. U.S. social security taxes (analogous to Canada's CPP premiums) have doubled since 1950. They'll likely have to double again just to keep enough money going in to support the ever-increasing segment of pension recipients.
The authors foresee the fall in price of some assets while others rise. For instance, they see stock prices suffering because there will be more retirees selling stocks to an ever shrinking segment of younger people. They figure the simple laws of supply and demand will apply downward pressure on stock prices.
On the other hand, investments that provide safety and inflation-protection are likely to be the last to be sold, hypothesize the authors. Since instruments like U.S. TIPS (treasuring inflation protected securities) and Canadian RRBs (real return bonds) provide what retirees need most, they're more likely to hang onto them longer.
They estimate that large homes, which once housed families of five, will see demand (and prices) fall since families will be smaller (as a result of slower population growth).
Goods and services that retirees tend to want/need may see prices go up, however. Since this could put pressure on wages to rise, to attract qualified workers, certain sectors (i.e. health care, leisure, and service industries) could see inflationary pressures.
We didn't have such problems from 1950 onward because the falling birthrate offset the rising rate of retirees, leaving working people more money to save, which the authors credit for playing a significant role in the bull market that ended three years ago.
When will these effects start to take place? The authors suggest they may already have, but figure such trends won't really pick up steam until about ten years from now.
The authors highlight three categories of solutions: financial, macroeconomic, and demographic. While they run through the pros and cons of various possibilities, they do conclude that some type of multi-pronged approach may be most effective.
Most importantly, they estimate that the age at which people choose to retire will rise from today's average age of about 66 to about 72 or 73 years of age. They argue that since life expectancy will continue to rise, us non-boomers will be much healthier and more vigorous by the time we reach our 70s and 80s - compared to those in that age range today.
They also suggest that liberalized immigration policies might be a solution. Allowing a targeted amount of immigrants each year (particularly people in their 20s) will help improve the ratio of workers to dependents.
Rising savings rates can have a small impact but overly aggressive savings by working people could rob the economy of ever-important consumer spending, which makes up 60 and 66 percent of the Canadian and U.S. economies, respectively. This is part of what has caused Japan's economic woes.
The authors estimate that the economy will adjust, as it has over the past century (i.e. we've become much more service oriented than we used to be). And as long as policy reforms are well crafted, the impact of the aging trend could be moderated.
I must admit that this was not the most uplifting article but it reinforces something I've mentioned many times in this space. Diversification (both for your investment portfolio and overall net worth) is critical over the long term.
Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at firstname.lastname@example.org
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