You'd had to have spent years in a cave not to know that the leading edge of 78 million Baby Boomers will begin turning 65 next year. There will be a lot more older people, and the worlds of senior healthcare, housing, lifestyle, and community supports will be under growing social and financial pressure to change a great deal. What is not so well understood is that these same demographic shifts could have a big drag on the values of homes, investments, and other financial assets.
These are unavoidable forces. Simply stated, older people tend to liquidate assets to fund their retirements. Younger people tend to acquire financial assets as their personal wealth rises and they build their own nest eggs. The U.S. has enjoyed nearly 40 years where the number of people acquiring assets was greater than the number of people disposing of them. This condition is about to be turned on its head. We now face roughly 40 years where there will be more people in this country wanting to sell financial assets than buy them. This supply-demand shift could put a lid on asset values and depress overall economic growth.
For people in retirement or getting ready to retire, the demographic message is clear. It would be unwise to assume a return to prior growth patterns for housing and investments. If you were counting on getting, say, $300,000 for your home, think conservatively about getting $275,000 or less. If you were forecasting your holdings would grow by four percent a year after factoring in the effects of inflation, see how your plans work if that number becomes three percent a year. And even these lower levels of gain won't be seen until the economy has limped its way back to whatever the new equilibrium looks like.
Now. a difference of one percentage a year in annual returns may seem small but it's anything but small, especially if you're compounding that reduction over 20 or 30 years.
This demographic snapshot is brought to you courtesy of a study by Elod Takats, who works for the Bank for International Settlements, a global rule making and financial think tank. Takats looked closely at the relationship between demographic shifts and housing values in 22 industrialized countries.
Housing values, he argues, provide a relatively pure read on the financial effects of population shifts within a single country. That's because the groups of people who are home buyers and sellers in the U.S. mostly live in this country. Investors, by contrast, increasingly choose securities from a global market. So if stock values go down in the U.S., for example, iinvestors here can shift some of their holdings to countries where investment values are increasing. Takats is comfortable, however, in using the change in a country's home values as a factor in also estimating the future valuation of investments and other financial assets in that country.
Looking at historical home values, he finds that there was an annual demographic "bump" of about eight-tenths of one percent in home values in the U.S. during the past 40 years. As the number of retirees swells to exceed the size of subsequent generations, this boost will be replaced with an equally large downward pressure on home values. Put another way, there could be a 1.6 percentage point swing in the annual downward pressure on home values in this country, from plus 0.8 percent to minus 0.8 percent. Takats is careful to refer to these numbers as either tailwinds or headwinds, and notes that lots of factors can cause the actual value of homes and other financial assets to differ from a pure demographically driven shift.
"House prices can grow substantially in spite of strong demographic" pressures, he says in the study. For example, household sizes are getting smaller, meaning there may be more demand for homes even if the total pool of people wanting to live in homes is declining. "Most importantly, long run projections and estimates should be treated very cautiously as their track record is dismal," Takats says. "Technology and economic relationships can and do change often with complex and unforeseen second round effects. Even demographic trends can change unexpectedly and the current consensus on aging might prove to be wrong."
In moving from housing values to the overall shift in asset prices, Takats concludes that population shifts may reduce the future rate of price appreciation for all global assets by about one percent a year. "The United States stock market has averaged an annual real return of 6.8 percent between 1802 and 2006," he notes. "Shaving off around one percentage point from this return would be substantial, but does not seem to have catastrophic implications."
This may be true for the overall economy but individuals could still face unhappy retirements if it turned out their income fell short of expenses by one percentage point each and every year.
If there's a silver lining in this population tale, it's that the U.S. is not facing nearly the aging pressures of Japan and most European economies. Relatively speaking, it will be harder for these countries to achieve high economic growth rates than in the U.S. And even China, which is fast becoming the biggest producer of seemingly everything, is aging rapidly. In only 15 years, the average Chinese will be older than the average American. In many respects, the Chinese may be forced to use their huge current budget surpluses to fund social safety nets for their aging population. The horde of U.S. Treasury bills they now hold may become their version of Social Security.