A new analysis from the Center for Retirement Research at Boston College examines the impact the ballooning number of retirees could have on the U.S. and global economy—and by extension on stock markets and asset management strategies.
As readers will know, CRR finds the “transition to an older society in the U.S. is primarily driven by the aging of the Baby Boomer generation and the drop in fertility that has resulted in little or no increase in the size of subsequent cohorts. As a result, the ratio of retirees to the working-age population in the United States will grow rapidly through the middle of the century and more slowly thereafter as life expectancy continues to rise.”
What readers may not be aware of is just how widely this trend will apply—well beyond the borders of the U.S. According to CRR’s findings, “the transition is global, beginning sooner in Japan and Western Europe and later in China and most other developing nations.” It stands to reason that such a fundamental shift in age demographics will dramatically influence economic conditions and investment opportunities.
“The long-term effect of this demographic transition on U.S. investment returns depends on how it affects the supply and demand for savings in the ‘real’ economy,” CRR anticipates. “This effect includes demographic changes in other nations that result in capital flows to and from the U.S. market.”
CRR’s high-level projection is that, should the supply of savings rise relative to demand, “the market-clearing return on savings declines—investors would receive less income from interest, dividends, or profits for each dollar invested. Alternatively, if the supply of savings declines relative to demand, savings can be invested in opportunities that offer higher returns.”
It is one thing for investors to be aware of these long-term market pressures, and quite another to know what to do with such information in the short- and medium-term. As CRR acknowledges, it is important to understand that transient capital gains and losses will not be driven by these effects in the short- and medium term.
NEXT: Demographics and market returns
While it will not shape all short- and even medium-term market moves, the demographic transition is expected to reliably affect the supply and demand for savings in two ways, CRR reports. First, by “sharply reducing the growth of the working-age population and by changing the overall age composition of the population.” The sharp deceleration in the growth of the working-age population “means that the economy needs far less savings to build new offices, factories, roads, and machinery than it had when the labor force was rapidly expanding. This decline in the demand for savings should lower investment returns.”
CRR’s analysis continues: “The changing age composition also matters, because the supply and demand for savings is likely age-related. According to the lifecycle hypothesis, in which households borrow, save, and draw down their savings to maximize utility over their lifespan, young workers, ages 20-39, increase the demand for savings as they borrow to purchase and furnish new homes. Older workers, ages 40-64, increase the supply of savings as they prepare for retirement by contributing to retirement accounts, reinvesting the investment earnings, and paying down mortgages and other debts.”
Retirees who are 65 and older, the analysis explains, “decrease the supply of savings by drawing down the assets accumulated in their working years over the course of their retirement to provide for their consumption needs.”
Taking this together, one can draw the conclusion that, “as the working-age population has already essentially stopped growing in the United States, Europe, Japan, and China, that demographically driven reduction in the demand for savings is already in place. Changes in the supply of savings, by contrast, will become more important as the elderly become an increasingly large share of the population.”
The full research brief is available here.