Will the Retirement Boom Lead to a Stock Bust?

April 1, 2013 — Leave a comment

Some people expect demand for stocks to decline given the large wave of Americans approaching age 65. This article questions this expectation.

Investment professionals often recommend that investors shift their investment allocation from stocks to bonds as they approach retirement age. The combination of the spike in people approaching retirement age, and growing longevity, may lead you to expect a big shift of demand from stocks to bonds. Below are several reasons why this big shift may never happen.

Bonds are too risky for the long run

While bonds reduce the short-term risk of stocks, they carry a risk of their own. The combination of inflation with increased longevity can erode the value of bonds, introducing the risk of running out of money, slowly and painfully. There are three ways to reduce this risk:

Work longer

People in good health, and with moderate assets, are likely to work longer. They may spend similar time in full retirement as retirees 50 years ago. They will do so by spending most of their increased longevity working, full time or part time.

Spend less

Those with health conditions that prevent them from working and without substantial assets will have to limit their spending to their social security income and whatever resources they have. Either they will reduce their spending early on in retirement, or they will gradually reduce their spending as they deplete their assets.

Invest in stocks, if you have the money

Those with substantial assets relative to their spending will benefit from the option to sustain a low withdrawal rate from their savings in retirement. When you can commit to a low withdrawal rate, stocks (globally diversified) are safer than bonds. Specifically, the risk of depleting the investments due to withdrawals during severe declines is very small. For those who happen to live long, the risk of stocks tends to keep declining, while the risk of bonds tends to grow.

Annuities do not solve the problem

Annuities are simply a window into bond investments (since insurance companies put money backing annuities in stable investments such as bonds), but with high administrative costs. They add the longevity protection and, in some instances, inflation protection, and reduce the income paid in order to finance these protections. Just as a retiree would not put substantial assets into bonds to finance increased longevity, he/she would not finance the bulk of retirement income using annuities.

Literature Support

A paper by the Congressional Budget Office (CBO), published in September 2009, provides evidence to support this article’s claims, with many interesting angles on the topic.

Summary

As people live longer, they have a choice between working longer, reducing spending, or investing more in stocks. Investment advisors and individuals are gradually realizing that bonds are too risky for financing the increased longevity. This realization may accelerate at times with elevated inflation.

http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/105xx/doc10526/09-08_baby-boomers.pdf

Disclosures Including Backtested Performance Data

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Gil Hanoch

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