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Baby Boomers and Investment

February 15, 2012

People invest primarily for retirement, and they build up wealth as they get older. When they retire, they sell assets to pay for their living expenses. When age cohorts are stable, is no impact on asset prices from retirement. However, when there is a demographic shift and lots of people retire at the same time, the elderly will sell off their assets, shifting out the supply curve and driving down prices.

Wealth by Age of head of household in 2004

A baby born in 1950 would be 62 today, just 4 years from Social Security retirement age. Given that life expectancy has continually improved over time, baby boomers are expected to spend more time in retirement than any previous generation.

Projected Demographics

Life Expectancy
Life Expectancy throughout history

Stock Market Returns
There are two key concepts for investments: returns and the value of the stock market. Returns are how much you get each year for a given investment. If a $100 stock pays $7 per year, the return is 7%, even if the value of the stock remains at $100 forever. The value of the stock market is the price of each stock times the number of shares of the stock. The value of the stock market cannot grow faster than the economy in the long run. The return on stocks can be higher than the growth of the economy, so long as dividends are not reinvested. In any event, it is unlikely that the stock market will return anything like it has historically in the long run. The capital stock can grow, but it faces diminishing returns, especially when combined with a shrinking workforce.

The Price to Earnings Ratio
FRBSF Estimate of Future Price to Earnings Ratios
The Price to Earnings Ratio is the price of a stock divided by the stream of dividends. It is highly variable, but does not have an upward or downward trend in the long run.

The Great Stagnation
In Tyler Cowen’s book, The Great Stagnation, he discusses how, since the mid 1970s, growth has dramatically slowed down. The economy has become dominated by a few highly regulated sectors which are slow to innovate, such as health care. Signaling, ineffective, futile, bureaucratized, end of life, health care. The areas with the most rapid growth are not things that old people spend money on, so the Stagnation will get worse, not better, even if technological improvement continues. Technology tends to make health care more expensive and more unequal. These is no sign that the government will become less involved in providing health care/insurance anytime soon, so there is little pressure on firms to cut costs.

Further Reading
Megan McArdle on Boomers
Boomers will reduce investment returns.
Fed paper on Boomers and investment
The Baby Bust
MSN Money on this topic

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4 Comments leave one →
  1. February 15, 2012 3:52 pm

    Not exactly optimistic, are you? What are our options?

    • February 15, 2012 5:01 pm

      I would say, focus on reforms of the “supply” side of things. Deregulate health care, convince people to be realistic about end of life care, invest in more medical schools and try to reduce legal restrictions on using nurses instead of doctors for everything. There is a lot of liscencing. We need to be honest that it doesn’t take an MD to do all health related tasks.
      I am actually blithe about the financial side of things.
      Real consumption now will be about equal to real production now, regardless of the financial trickery we perpetrate. If there are a lot of non-working people, working people will have a lower consumption levels. There is nothing anyone can do about it, so don’t bother worrying. Pretty much all countries will hit a demographic crisis around the same time, so international transfers won’t help much.
      For personal investments, just be aware that investment returns will be utter crap for the next couple of decades. Do with that information what you will.

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