It's the Demographics

Baby boomers headed for retirement face a tough scenario. So says financial scholar and businessman Robert D. Arnott in this Wall Street Journal interview. The reason for this challenge, he says, is not due to recent economic difficulties, but rather to changing demographics.

The parents of baby boomers were able to retire (sometimes compelled to retire) at a relatively young age because so many new workers (i.e. boomers) were expanding into the work force. "The surge in that population [in the U.S.] in the '80s and '90s," says Mr. Arnott, "helped to fuel the U.S. stock market boom in the '80s and '90s;" a period that he says was "extraordinary."

But the average baby boomer has produced fewer offspring than did the average member of her/his parents' generation. This means that the supply of workers entering the work force as baby boomers retire is much smaller in comparison to the cohort entering retirement than in the previous generation.

Mr. Arnott says that less than 10 years ago "we had 10 new additions to the working-age cadre for each one new senior citizen." Today we are almost at even par, with about one new worker for each new senior citizen. During 2012 that scale will tip toward the older demographic. In 10 years there "will be 10 new senior citizens for each new working-age citizen."

Why is this important? After all, weren't boomers the ones that thought that having smaller families was a mark of enlightenment? It turns out that retirees can't support themselves on their own. Retirement is built on the economic and financial foundation created by the younger working generation. Boomers simply didn't create enough of that younger generation to supply the kind of abundance many retiring boomers expect.

To underscore the importance of this demographic shift, Mr. Arnott says, "If that's not a political, economic and capital-markets game changer, I don't know what is."

The article explains how this will apply to boomers' retirement nest eggs:

"As retirees sell stocks and then bonds to support themselves, there will be fewer younger investors to buy those securities, keeping a lid on prices. Meanwhile, strong demand from boomers and a limited supply of workers will boost the prices of goods and services the boomers need."

Many people are expecting investments to perform the same way they did in the '80s and '90s, says Mr. Arnott. But the demographic shift makes this impossible. Instead of 8-10% annual pre-inflation growth, we are more likely to see a 5.5-6% rate.

The double-whammy described above means that boomer retirees will have less money to pay for higher priced goods and services. Many will live far more modestly in retirement than they had hoped.

Still, says Mr. Arnott, the U.S. isn't in as harsh a situation as Japan, which experienced a similar demographic scenario a decade ago. Japan's ratio of retirees to young workers is more severe than the U.S.'s. Some observers have suggested that immigration of workers (a factor that is minimal in Japan) will help to blunt the current demographic trend in the U.S.

Mr. Arnott also notes that the boomers' situation isn't necessarily as bad as it sounds. They can improve their lot by investing "in economies that aren't afflicted by the 3-D hurricane of deficit, debt and demography." (The U.S. is obviously included in that hurricane.)

Sensible investors, says Mr. Arnott, should be able to retire perhaps a year or two later than originally planned. Those that invest "conventionally" can expect to work a couple of years beyond that. Those that rely mostly on entitlements, however, will "work until they're 80."

The advice then, is to invest offshore in economies that are more vibrant and not demographically constrained. It would also seem that the U.S. is in for many years of relatively lackluster economic performance, thanks to the demographic trend. Maybe reducing family size isn't as smart as some have made it out to be.