Hey Babyboomers: Stay Healthy, Don’t Retire

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If you are a baby boomer considering retirement, Carden Capital has some advice for you: stay healthy and don’t quit your job. For too many baby boomers, retirement will be more stressful than it was hoped. The fun, leisure, and financial security which previous generations of retirees enjoyed are now imperiled.


What’s the cause? There’s a simple supply and demand problem.  The number of retirees is growing in relation to the working population. An unusually high amount of people are beginning to retire at the same time, while the number of young folks entering the workforce is not growing fast enough to keep the ratio constant. The combination is causing rampant inflation in retiree-specific sectors, such as health care. It also threatens to dampen returns for various assets including stocks and bonds.


Let’s Talk About Your Retirement Plan


When figuring out a retirement plan, there are three factors in play. How long will you live, what your expenses will be, and what returns you will earn from your capital.


Thankfully, given the rapid rate of medical advances in recent years, life expectancies continue to rise. This benefit of modern society does require us to plan for extended longevities of our retirement portfolio plans. Also, while lifespans continue to increase, many of these medical advances are allowing us to live longer while in poor health as diseases such as diabetes become more widespread. Don’t assume that an additional year of life at age 90 will cost the same as at 65 in terms of health care costs.


Health care costs are also rising for another reason related to demographics. Yes, drug prices, expensive lawsuits, government regulation, and so on all play a part in escalating costs. However, there’s one key often-overlooked element. There simply aren’t that many young people to fill posts in nursing and other such hands-on health care jobs. The cost of labor in the health care sector will continue to escalate. This will be discussed more in a minute.


Finally, a good retirement plan must consider what realistic return can be achieved on capital. The average pension plan in the United States assumes a 7% annual return. Many individual investors who became familiar with the stock market during the roaring 90s still anticipate 8% to 10% a year. Popular financial advice pundits such as Dave Ramsey tell listeners to expect 12% annual returns from the stock market.


Sadly, we must come to grips with an uncomfortable truth about returns on investment in coming years: They’re going to be really low.


For a visual demonstration of just how bad things could be, consider this 7-year forecast of investment returns by asset class, adjusting for inflation from GMO:


pst_asset return forecast


As you can see, based on historical returns, given the current starting valuation levels, most assets are expected to produce negative real returns over the next seven years. US large-caps could quite possibly lose money even before considering inflation.


Developed international markets are also likely to trail inflation. Interest rates are so low, due to numerous rounds of quantitative easing, that bondholders are making almost no money currently, and should rates increase, they will face losses on their bonds and equities.


The only relatively acceptable equity returns are likely to come from emerging markets. And most retirees or near-retirees are very uncomfortable, with good reason, about the idea of betting heavily on emerging markets. In the bond market, everything other than emerging market bonds are likely to only barely match inflation, if that.


Not a single asset class is likely to produce the average 6.5% real return that US stocks generally have produced in the past. Unless you’re comfortable plowing your money into emerging markets and timber, you’re not that likely to get any sort of significantly positive real returns in the coming seven years.


The situation over the next seven years is dour due to the inflated valuations that central banks have helped promote with their aggressive actions that have propped up markets. This has pulled forward returns from the future; it makes investors feel wealthier today, but in the long run, it doesn’t do anything to change the market’s overall return profile. You trade off worse returns in future years for the artificially good ones global markets have just experienced.


There is, however, one silver lining. Stocks are likely to be volatile, but they won’t just flatline. There are likely to be numerous 20 or 30 percent swings along the way, even if the net result is flat. Using an intelligent timing system such as the Carden Smart Hedge Index could allow investors to benefit from the rallies within a choppy market.


Demographics: The Elephant In The Room


If valuations were merely stretched due to overaggressive central bank activity, that’d be one thing. A seven year skinny period, followed by a return of normal robust portfolio returns would not be a terrible prospect.


However, things are likely to remain difficult for market returns in the years beyond 2023. By that point, a different concern will be weighing on markets.


Fundamentally, the price of goods is set by supply and demand. Be it stocks, bonds, housing, gold, food, health care, oil, you name it, the long-term trend in price is most effected by changes in supply and demand. This causes a unique set of problems when there’s a large demographic shift.


It’s worth remembering that folks generally have rising net worth as they age until they’ve retired. You can see this in recent data from the US Census Bureau:


pst_net worth by age


People under age 45 have hardly any wealth, either in liquid assets such as stocks or in real estate. However once people get enough promotions and child-rearing related expenses diminish, wealth can take off. The majority of American wealth is accumulated in the twenty or so years before retirement.


This is a normal pattern, and it works fine with a growing population. However, the American demographic pool is shifting. Starting with the baby boom generation, Americans have had children mostly at the replacement rate, a trend which has continued. The population pyramid, a typical structure of a growing population has since flattened out, and population growth has increasingly come from immigration.

pst_1950 population pyramid

pst_2014 population pyramid

Throughout the 19th and 20th centuries, the population in developed countries grew rapidly and the world’s wealth grew dramatically. Pretty much all the economic and asset price data that the world uses to study and forecast asset price returns is from this time of rapid population and economic growth, simply because prior to this time, not much hard data exists. This means all the growth patterns that economists have studied rely on having a population pyramid close to what the US had until recent years. With a larger new generation always coming to replace the retiring generation, a growing tax and consumer base was ensured. The needs of retirees; be it for health care workers, people to fund their entitlement payments, or purchase their assets was always there.


The population no longer is a pyramid, however. The large bulge is in the group that is set to retire in about 10 years. There are barely enough children to replace the workers that will be lost to retirement; there certainly won’t be much fuel for future economic growth.


There’s also a unique problem. Retirees rely on young people to fund their retirements beyond the transfer payments that go through the government. Look at the chart of net worth again. Notice that the majority of a median retiree’s net worth is in her house, not in her stocks or other liquid savings.


It’s common for retirees to sell their house or trade down to a smaller place to free up cash. This traditional transaction requires a buyer for the house. The last few years have shown that millennials increasingly aren’t interested in or capable of buying houses. Many are living in apartments for extended periods of time. Whether the suburbs have lost their charm or student loans preclude young people from being able to service a monthly mortgage, the conclusion is the same: There won’t be enough housing demand to meet the coming wave of supply that the retirees will put on the market.


In 10 or 15 years, you’re going to see a lot of retirees try to sell their homes into a housing market with surprisingly few buyers. It will likely leave many retirees with less actual equity than they’d calculated and also lead to issues at some banks that lent too heavily against devaluing houses.


Houses aren’t the only place where supply will outstrip demand.  The stock market will face a similar problem. Notice how small the current portion of the population is that is 35 to 44 today? That group will be 45 to 54, the peak stock-buying demographic in the US. This is the group that primarily needs to absorb all the shares that retirees are counting on selling to pay bills. Again, when supply outstrips demand, you’ll see share prices fall; economics mandates it.


The persistently high PE ratio of US stocks in recent years has been driven by the large group of baby boomers regularly buying stocks. The ratio will deflate once there are more retirees selling stocks and fewer workers contributing to 401Ks and IRAs to absorb the supply.


Against this backdrop of falling equity in both housing and the stock market, you’re likely to see health care costs continue to escalate. The economy simply wasn’t designed to tend to so many retirees with such a small working age population, and there will be uncomfortable disruptions as the market shifts to accommodate the new normal.


Japan: A Preview of the Future


For investors and retirees trying to work out the effects of this future transition, there’s a helpful example to refer to: Japan. In 2000, Japan had a population pyramid similar to that of the US today:


pst_japan population pyramid


The US situation isn’t quite as dire, the US has somewhat larger under-14 year-old population now than Japan did in 2000. Still, the similar bulge in the 50-59 year old population with a deficit of workers immediately below them to pick up the slack is an exact match.


The Japanese stock market famously crashed in 1990. It’s never gotten remotely back toward the levels it reached at that peak. But the fact less known is that buyers have gotten horrible returns almost regardless of when they’ve purchased in recent decades:


pst_nikkei 225


In 2000, Japanese stocks were at 20,000, still 50% below the all-time high, but well up from the worst levels. For long-term buy and hold investors, it was tempting to believe that after the aberration of the 1990 bubble, Japanese stocks were again a good long-term investment. Certainly, if you’d been raised watching the market effortless rise from the 1950s through 1990, you thought Japan’s stocks could only go up in the long run.


Instead, facing nearly the exact demographic picture that the US sees in 2016, Japanese stocks plunged again. From Nikkei 20,000 to start the decade, stocks fell more than 50% additionally. The only catalyst for growth in Japanese equity prices has been the Japanese central bank. Massive quantitative easing in the last three years caused equity market to finally move. Not only was the Japanese central bank buying debt, it has also purchased large quantities of equities and is now a top 10 shareholder 90% of the Nikkei 225 index constituents.


Remember that Japan hasn’t seen its central interest rate sit above 1% since 1995 either! For Japanese retirees, there’s been no way to generate good returns without investing abroad. The result? The Japanese elderly are now intentionally committing crimes so that they can get taken care of in prison.


The US situation won’t necessarily turn out quite that badly, but things are heading very much in the same direction. With interest rates already at historic lows, returns from bonds will not be anywhere close to past averages, while the stock market faces a period of dampened returns.


Our Advice: Focus On Risk Management While Working Longer


Many retirees make a decision to retire when they hit their “number.” This is often a figure such as $500k or $1 million where a potential retiree feels secure in being able to live out their days comfortably off the proceeds of their saved funds along with their government benefits.


This can be risky though. There were big waves of retirements in both 1999 and 2007. The elevated market made it seem as though there was enough money for these people to leave the workforce. However, stocks plunged on the newly-retired, sending their net worths to levels far below their numbers. Adding insult to injury, it’s often difficult for older folks to get rehired. Age discrimination is a real concern in many industries; besides that, in a falling economy, companies are less likely to hire anyone, regardless of age.


With the stock and bond markets now boosted to overvalued levels due to global central bank machinations, there is real risk of potential retirees misreading the signs. Portfolios have grown greatly in the past few years; but when it comes time to turn that paper capital into real checks that pay the bills, shares may slump.


Before turning in your two weeks notice, ask what would happen if the market corrected 25% in your first year of retirement. If you’d feel compelled to try to re-enter the job market, realistically consider what sort of wage you’d be able to obtain.


Similarly, if instead of being able to earn 7% a year, as most brokers will claim is easy, what happens if you can only earn 3% safely? That 4% withdrawal rule doesn’t hold up very well if there’s a realistic chance of you living 25 years after you retire and your assets are only generating 3%.


Besides working longer, the next best option for improving the viability of your retirement plan is to limit risk. One of the best ways to achieve this is by using a system that responds to market volatility; limiting losses and sidestepping the steep market tumbles. There are many ways this can be achieved. However, for many people, the best way is an automatic system such as the Carden Smart Wealth portfolios. These are designed to capture most of the market’s upside while avoiding the crushing drawdowns such as 2001 and 2008 that derailed many retirees’ plans.


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