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 Serling, 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, B.Comm., CFP, CFA is the Senior
Investment Analyst with Sterling Mutuals Inc. He can be reached at dhallett@sterlingmutuals.com Sterling Mutuals Inc. is registered as a
mutual fund dealer in Ontario, British Columbia, Alberta, and Manitoba.