Baby Boomers: The Biggest Threat to Your Investments?

Before you go, we thought you'd like these...
Before you go close icon

In case you're at a shortage of miserable news stories, here's something else to worry about. According to a recent Federal Reserve paper, retiring baby boomers could sink the stock market over the coming decades.

Baby boomers are, of course, a large generation. And when that large group begins retiring en masse, they will liquidate assets. All that selling, the Fed reckons, will keep stock valuations low for the next two decades.

By a lot, too. "We find that the ... P/E ratio should decline from about 15 in 2010 to about 8.3 in 2025 before recovering to about 9 in 2030," the Fed writes.       

That's serious stuff. To state the obvious, if earnings double, yet the earnings multiple falls by half, stocks go nowhere.

The Fed's analysis is based on taking the ratio of two groups, the middle-age (40-49) and old-age (60-69) cohorts, and comparing it to the P/E ratio of the S&P 500. Over time, it found a connection:

anImage

Source: Federal Reserve.

And concludes:

[B]etween 1981 and 2000, as baby boomers reached their peak working and saving ages, the M/O ratio increased from about 0.18 to about 0.74. During the same period, the P/E ratio tripled from about 8 to 24. In the 2000s, as the baby boom generation started aging and the baby bust generation started to reach prime working and saving ages, the M/O and P/E ratios both declined substantially.

Extrapolating that trend out over the next two decades, and factoring in projected changes in age demographics, is how the Fed forecasts the drop in P/E ratios.

Scary stuff. But should you buy it?

I think there are two reasons to be skeptical.                    

Before we get there, there's an important point to make. There seems to be a notion that baby boomers depressing stock values is a disservice to younger generations. It's quite the opposite. If the Fed is right, it's the baby boomers who will suffer. Only those in the selling phase of their investment lifecycle should want high stock prices. Over the next 20 years, that's the baby boomers. Younger generations in the accumulation phase should love lower valuations.

But the Fed may very well be wrong.

First, its forecast rests on the fact that stock valuations were low in the 1980s, rising in the 1990s, and dropping in the 2000s -- and that changes in age demographics fit those time periods nicely. But regardless of what its models say, it seems a bit rich to say this was causation, rather than random correlation.

Above all else, stock valuations were low in the early 1980s because short-term interest rates were in the double digits. It didn't make sense to pay 10 times earnings for a stock when you could earn 15% in a money market account. And valuations were high in the 1990s because of a momentary lapse of sanity. Dot-com stocks didn't trade at a zillion times revenue because baby boomers were in their prime earning years; they traded that high because the world was stuck in a this-time-is-different mindset that pervades all bubbles. Declining valuations over the past 10 years have been a correction of that bubble. All of those events could have -- and likely would have -- played out regardless of demographics.

More broadly, the question of who baby boomers will sell their retirement assets to can, I think, be answered simply: the younger generations.

The baby boom generation is associated with being huge because it's considerably larger than generations before it. But those baby boomers had kids. Lots of them. There are now millions more Americans between age 20 and 35 than age 50 and 65. Broken out by generation, the U.S. has a fairly young population:

Age Cohort

Number of Americans (2010)

Percentage of Total Population

<2083.2 million27%
20-45102.7 million34%
45-7091.8 million30%
>7026.6 million9%

Source: Census Bureau.

This is hardly the face of a demographic time bomb. Far more Americans will be entering their prime earning years than will be entering retirement over the next two decades.             

Compare that to Japan, a country with a legitimate demographic nightmare:

Age Cohort

Number of Japanese (2009)

Percentage of Total Population

<2023.5 million18%
20-4540.1 million31%
45-7042.3 million33%
>7021.6 million17%

Source: Census Bureau's International Data Base.

And there's reason to think that today's younger generation will actually be more stock-oriented than their boomer parents. For older generations, the central road to retirement is a pension and Social Security. For younger generations, it's a 401(k) and a belief that Social Security will be gutted by the time they're eligible. The latter group will be far more dependent on private savings and -- importantly -- investment returns (pensions also invest in stocks, but a large part of current pension benefits are funded through capital injections).

Younger generations are already heading that way. Consider the new trend in automatic 401(k) enrollment, in which new employees are automatically pushed into a retirement plan, but can opt out if desired. In 2005, 5% of businesses used automatic enrollment. Today, 38% do. Not only are there more younger Americans than baby boomers, but that younger group may end up putting a larger percentage of their income into retirement assets. This again might help answer the question of who will buy baby boomers' stocks: their kids.

Maybe the Fed is right. As a member of the younger generation who will be accumulating stocks in the coming decades, I hope they are. But like most predictions of doom, it should be viewed with a level of skepticism. The future is usually better than the past. No reason to think that's changed.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

At the time this article was published Fool contributorMorgan Houseldoesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel.Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners