baby boomers

Retirement.  A concept of the late 1800s to the present.  Easy to swallow when the population is growing rapidly.  Tough to do when populations are growing slowly, much less shrinking.  I would point you to two articles I have written:

With stock prices high and interest rates low, many people look at their portfolios and smile: high current market values.  But what would happen if you had to turn it into income?  Interest rates are low.  Dividend yields, though better than the past, are still pretty low.  This is another place where total return blinds us to economic reality.  If market values have risen solely because people are desperate for yield, earnings, etc., and not because future productivity is likely to be far higher, the rise in asset values does not represent a rise in distributable cash flows, which is what investors truly need.

Think of this a different way, and ignore markets for a moment.  How do we take care of those that do not work in society?  Resources must be diverted from those that do work, directly or indirectly, or, we don’t take care of some that do not work.

Back to markets: Social Security derives its ways of supporting those that no longer work from the wages of those that do work.  That’s one reason to watch the ratio of workers to retired.  When that ratio gets too low, the system won’t work, no matter what.  The same applies to Medicare.  With a population where growth is slowing, the ratio will get lower. If the working population is shrinking, there is no way that benefits for those retiring will be maintained.

Pensions tap a different sort of funding.  They tap the profit and debt servicing streams of corporations and other entities.  Indirectly, they sometimes tap the taxpayer, because of the Pension Benefit Guaranty Corporation, which guarantees defined benefit pensions up to a limit.  There is no explicit taxpayer backstop, but in this era of bailouts, who can tell what will be guaranteed by the government in a crisis?

Current low interest rates imply that there aren’t a lot of highly productive projects yearning for capital.  This is a product of overly easy monetary policy that never let recessions clear away bad projects.  Low interest rates make future promises more expensive for defined benefit plans, and make it harder to accrue assets for defined contribution plans.

Do you have one million dollars socked away yet?  No?  Under optimistic assumptions, maybe you can earn 4% on your money without touching the principal.  That would give you $40,000/year pre-tax.  Add in Social Security, and maybe you can make things work.

If you want to give up liquidity, and any sort of estate for heirs, you could annuitize all or part of your assets, bringing your yield up 1-2%.  For whose who have less money, that could make things work.

That said, inflation could throw a monkey wrench into all of this.  Buying inflation protection knocks around 0.5% off yields.  But who knows how much the government will encourage or discourage inflation?  That is the leading open question at present.

Retirement Summary

So long as interest rates remain low, and asset values high relative to replacement cost, funding retirement will be an expensive proposition.  Not many will be able to do it.  As population growth slows, government entitlements will prove difficult to maintain at current levels.

As such, we should expect older people to work longer than their parents and grandparents did.  In many cases it will be “Work till you die.”  The idea of retirement as a long vacation at the end of life will only be true for the well-off, a minority of the population.

And compared to prior history, that’s how it should be.  A comfortable retirement is an expensive proposition, and not something that can be given to everyone by government fiat.  The economy only has so much productivity; to the degree that retirees suck off resources, there is that much less to help the economy grow.

I write this as a 52-year old man.  I have opportunities ahead, but for most people in the Western nations, as demographics lead to older populations, economies will decline unless something comes to revive growth in population.

To those who are older, I say “Be ready to work.”  To those who are younger I say, “Plan and prepare, save, and figure out how to supplant the oldsters who occupy the positions you want to have.”

It’s not going to be easy over the next forty years.  But if it were easy, everyone could do it.  Instead, those who are prepared will do it.  And so my readers, get ready to do it.

By David Merkel, CFA of Aleph Blog