THE BLOG
08/05/2014 01:17 pm ET Updated Oct 05, 2014

The Demographic Threat to the Market

When it comes to stock and bond market commentary, doomsayers always hold a prominent place. Usually, they make their case on one of two bases: some pattern that vaguely resembles some past disaster or some relatively recent shock. Sometimes they are right. Of late, the doomsayers have fastened onto a third source of concern. The retirement of the large baby-boom generation, they worry, will force large numbers of people to liquidate their savings, a selling pressure on stocks and bonds that could drive down prices. Some looked for an imminent market crash on this basis. But if this story, like so many other scare stories, harbors a kernel of truth, the worry is vastly overstated.

To be sure, the broad demographic picture has much in it to fear. According to the Bureau of the Census, low birth rates over the last few decades will slow the flow of young people into the workforce just as the retirement of the baby boom and increasing longevity will enlarge the proportion of dependent retirees. The number of working-age people will fall from an already low 5.2 available to support each retiree today to barely 3.0 by 2030. So, indeed, the picture does suggest that people increasingly will draw on their savings and liquidate their financial assets while the relative paucity of working-age people will limit flows of new savings, contributions to pension plans, and purchases of investable assets generally.

But if this picture leaves reason for longer-term economic and investment concerns, and will ultimately force many changes in this economy and its financial markets, immediate fears about market pricing are misplaced, and for at least four compelling reasons.

First, changing demographics, while it increases numbers of retirees, will also alter their investment strategies. Decades ago, people planned at most for five, maybe ten years of retirement. All but the wealthiest liquidated assets and drew them down quickly on retirement. But today, people can contemplate 20 or more years of retirement. Pensioners will need to draw down on their asset base much more slowly than their fathers and mothers did, much less their grandparents. Striving to protect the principal of their investments over a longer planning horizon, they will tend to keep much more of their portfolio invested for longer than did previous generations.

Second, the investment industry is also changing. Financial advisors are shifting toward a fee-based instead of a transaction-based business models, giving them much less reason than they once had to move assets about. According to industry sources, registered investment advisors (RIAs), almost none of whom are transactions based, are the fastest growing segment of the industry and are already 25 percent of the nation's wealth-management business. Even major national brokers are moving from their old transaction-based approach toward the fee-based model. Morgan Stanley Wealth Management, the nation's largest, reports 37 percent of its assets are fee-based. Bank of America's Merrill Lynch reports 44 percent, and Wells-Fargo 27 percent. The proportions are growing fast.

Third, pension funds are less likely to liquidate their holdings than they might have been. They actually face legal restraints that should prevent much of a drawdown in assets. Social Security excepted, all pension funds, even those run by state and local governments, must by regulation maintain an acceptable level of funding. If contributions from existing workers cannot support that level, then the sponsor of the fund must direct other revenues toward it. Corporations will have to channel their profits toward pension investments, and public authorities will direct tax monies into their pension funds, both effectively putting them into financial markets at a pace that offsets withdrawals.

Finally, the demographic impact, such as it is, will face a considerable delay. In this regard it is noteworthy that the biggest birth years of the great baby boom came toward its end, between 1958 and 1961. The birth rate figures of the time tell the story. Census figures show that at the beginning of the boom in the late 1940s, women had on average about three children in their lifetimes. That figure rose throughout much of the 1950s, hitting highs of 3.7 by 1957, a 20 percent gain. The birth rate stayed at that high level until 1961, after which it began its long decline. The bulk of the baby boom, then, is in its 50s, far from retiring. They are, in fact, in the highest earning and highest saving period in a person's lifetime. Their build up in pension assets will for some time to come more than offset any drawdown from the older, smaller, retiring part of the baby boom generation. Trouble will start when this group retires, but that will not begin until 2022-23, and even then, their biggest asset drawdowns will wait still longer to occur.

This less frightening picture does not ignore the ill effects of the demographic trends. On the contrary, it recognizes the very real and detrimental financial and economic impact from the growing mismatch between dependent retirees on the one hand and a relative shortage of taxpaying, saving, pension-contributing producers on the other. This fact of life in the United States will weigh heavily on the years after 2025 and force dramatic change in business practice, production emphasis, and public policy. But the panic over the immediate market impact is misplaced and sadly typical of those who prefer drama to reality.