Yellen winter is coming 3 widenedMy first job after college was working at a management consulting firm.  Consulting interviews would feature “hard-to-quantify” questions like “how many tombstones are sold in the US annually?” or “what would you guess Coca Cola’s various expenses were as a percentage of sales?”  They would typically give you about 10-15 minutes to work through the estimate and discuss the rationale.  The reason for this line of questioning is that part of the job is developing estimates of hard-to-measure drivers.  Some people call it “making up numbers,” but tomato-tomahto.  Here is my estimate for the impact of Baby Boomers on the total level of investments.

160404 US PopulationOne of the major causes of the elephant in the room (see last week’s CA) is a demographic shift.  We had a massive increase in population in the decades following WWII (aka the Baby Boomers).  On the right is a chart showing the yoy population change in the US.  That big hump in the middle of the chart (highlighted by green oval) is the post-WWII period – the Age of the Baby Boomer.  Note that this is a chart of the actual increases in headcount.  Considering that the base population back in the mid-1940s was less than half of what it is today, that was a phenomenal surge in terms of birth rate.  The reason why I am showing the actual headcount is because each person needs a certain amount to retire.[1]  People accumulate assets over a working lifetime, so that they can retire and enjoy their remaining years.  What is the impact of the green oval on the markets?  I claimed last week it was on the order of ten trillion of dollars.

But first, let’s look at the red oval (the two decade period surrounding the Great Depression and WWII).  The reason Social Security was started was because the stock market crash wiped out a lot of people and the poverty rate among senior citizens was over 50%.  For people born in 1930, the average life expectancy at birth was 59.7 years.  When 1995 rolled around and these people needed to retire (assuming age 65), frankly, the “average” person was dead.  When you are expecting only to live to 60, you just plan on working your whole life and so saving for retirement is not a priority.  Especially not with this fancy new “Social Security” around to take care of you, should you need it.  For people born in 1940, the average life expectancy was 62.9 years.  This is pretty much the same thing – no pressing need to save for retirement.  By the time 2005 rolls around to retire, the “average” person was again, dead.  And people born from these two decades were probably sufficiently spooked by their parents’ horror stories from the Great Depression to not want to invest.  To summarize, not only were there fewer people born in this “red period,” they did not live that long, plus there may have been a stigma to investing.  So in past decades, the lift from retirement savings on the markets from these folks was relatively small.

Starting in 1950, people’s life expectancy at birth bumped higher to 68.2 years (71.1 for women).[2]  401(k)s started in 1978 (when they were a young lad/lass of 28), where the company incentivizes you to invest.  To summarize, there were a ton of people born in the green oval, they lived longer, plus their companies started putting money in an investment account for them.

In any event, the number of people born in the two decade period between 1947 and 1966 is 55 million.[3]  To have an adequate retirement, the typical American probably needs about $500K.  As an annuity, this is about $25K per year.[4]  These are somewhat conservative estimates.  So $500K x 55 million people = $27.5 trillion in assets for retirement.  The entire US equity market was only worth about $26 trillion and the entire US bond market was $39 trillion last year.

But of course, the average person is not going to have or need $500K sitting in an account.  Social Security allegedly provides something on the order of 50% of the median retirement income.[5]  This brings us down to $13.75 trillion ($250K per retiree).  Here are some other downward adjustments we need to make:

  • Should savings tied up in real estate investments (equity in the house you live in) count? Home equity as a percentage of net worth is about 25%.  It really depends on if you want to include real estate in the discussion.  But some retirees may (eventually) go to the markets to monetize their equity somehow (as an annuity, HELOC or reverse mortgage).
  • I am looking at a 20 year range, and the average age now is only 59.5. They will not have by that age, the full $250K they will need for retirement.
  • Many retirees may be undersaved for retirement. They are going to have to come up with some money somehow.
  • Many retirees may not have an adequate exposure to the financial markets. It’s possible that many older people do not feel as comfortable with investing (especially after the last crisis).
  • I am attempting to measure marginal impact on the markets. It’s not as if the people in the red circle had no  And even a few decades ago, the current retirees would have had started retirement savings.  So the net marginal increase in investment will be smaller.

But the above are offset somewhat by these upward adjustments:

  • Those are median income numbers and the mean income numbers are 40-50% higher. So the mean retirement savings should also be higher.  I’m pretty sure none of you expect to retire on $250K (assuming you live in the US) in liquid assets.
  • If you modeled actual savings for retirement (where very little is saved in younger years and more in later years), this would magnify the population effect of the increase in investments in recent years.
  • While 401(k)s have been around for a while, it probably took a while for assets to start accumulating to a meaningful level.
  • Forward-looking people will see the longer life expectancies and should adjust by saving more. People are living to almost 80 now.
  • The group that follows the Baby Boomers will also have started saving for retirement.
  • If you are in most unions, or a firm with a defined benefit pension plan, you will probably retire with much more than the “average.” And you probably have investments in addition to your pension fund’s assets.
  • US assets are relatively more attractive to the rest of the world. There are 323 million people in the US.  But you would have to think the 508 million people in the EU (or 852 million people in Europe), and 126 million people in Japan must be eying US assets like I look at a well-marbled steak.  Staring at a 0.13% ten yield in the Bund or a -0.06% yield in ten year JGBs is like looking at the side of brussels sprouts.  Europe and Japan were also “active” in WWII and have their own Baby Boomers going through the same investment decisions.  I’m pretty sure almost no American is going to want any “brussels sprouts,” while many foreign investors may look over the ocean at our “steak.”  The net flow of investment capital is going to be one-way.
  • And let’s not forget the Chinese/Middle East/South American Baby Boomer money that want to escape here. The flows here are probably more two-way.

Obviously, this is just a back-of-the-envelope estimate.  I’m not claiming that this analysis is thorough in any way.  It’s closer to what I would say in 15 minutes at a consulting interview if someone asked me what my estimate of the (global) Baby Boomer effect on the US investing “elephant” was.  It’s not clear which set of factors (the first or second set of bullets) are greater.  On net, it’s probably “close” to a wash.  Last week, I my initial estimate was $10 trillion, but after listing everything down on paper, I could see some downside on that.  It’s almost like a FOMC dot plot – huge margin for error, but at the end of the day, something that I think is reasonable, with some downside risk (but not enough to warrant a change in the balance of risks).

Did I pass the interview?  Well, let’s see… in a short google search, the following estimates seemed reasonable:

  • The Employee Benefit Research Institute did a study and found that 56.7% of early Boomer households are on track to be ready for retirement. In skimming the survey, there was no mention of the top-line number they were using to base the “shortfall” on.  I assume this is because it varies by age.  57% is pretty good… because as much as I love America, there is a sizable contingent of my people who are slackers and/or clueless.  It’s probably the same in every country.  As an average, I would expect the top 10-20% (who could have multiples of what they need for retirement) to make up for a chunk the shortfall of the bottom 43%.
  • The other study was done by Blackrock (the company that makes money from investing your money), and they show that the average retirement savings for American “Baby Boomers” (aged 55-65) is only $136,200. I am looking at 49-69 year olds (close enough), and their figure is about 50% of my figure.  That’s pretty close (for a back-of-the-envelope calculation).  They found that 54% of Americans are positive about their financial future.  And factor in that they have an incentive to show lower numbers (not saying this would motivate them in designing the study favorably… eh hem), to get people to invest more.

But it’s really not important what my estimate is.  This was not intended to be some kind of thorough analysis.  I just wanted to give you food for thought, and the start of making your own estimate.  What is important is that this demographic factor is there, and it is not small.  The Baby Boomer population shift is one of the reasons why I think assets are noticeably rich now.  But just as ants saving for the winter (buying assets), when winter comes they will start consuming (selling assets).  Most Baby Boomers are still saving now.  The average retirement age has moved higher, but the first few years of Baby Boomers have retired already and have started digging into these assets.  Currently, we still probably have more inflows than outflows from the Baby Boomers.  But this will not always be the case.  Winter is coming.

[1] The reason why I am using population and not births is to somewhat factor in mortality around the Great Depression and WWII.

[2] And by 1960, the life expectancy was 69.7 years (73.1 for women).  The estimate for 2010 is 78.7 years (81.1 for women).

[3] The official definition of a Baby Boomer is someone born between 1946 and 1964.  I am using 1947 to 1966, which is close enough.

[4] These numbers are in-line with median personal income of $32K (for people above 25) and with Social Security “average 60-something” benefits of $16K per year contributing about 50% of retirement benefits.

[5] The Social Security Trust Fund only has $2.8 trillion for EVERYONE (not just incremental Baby Boomers).  But since Social Security is a Ponzi Scheme, it doesn’t matter how much money they have.  Eh hem.