Outlier Insights readers have been sending in great feedback over the past several weeks. It’s been great to hear your thoughts.
And one recent reader question got me thinking…
Giulio P. wrote in:
Mr. Bodner, I understand and appreciate your comments about deleveraging and the BMI approaching -25%. But no one has discussed the impact of the boomers retiring and the big drop in investment capital that will be happening.
You have the technology and data to suss this out. Could you please write a column on the expected impact over the next few years of the decline in capital available?
Giulio brought up a really interesting topic that we’ll discuss in today’s essay…
What impact will the retirement of the “baby boomer” generation have on the markets?
Baby Boomers Are Exiting the Workforce
Baby boomers have been hitting their retirement years for some time now. Yet since the pandemic, they’ve been leaving the workforce in droves.
COVID-19 accelerated many people’s plans to retire. As the pandemic hit, the percentage of working Americans over age 55 plunged to just 33.3% – a steep 6% drop.
This is having ripple effects throughout the economy.
Baby boomers were the largest cohort of Americans up until 2019… And they’re expected to remain the second-largest population group until 2022.
So their choices play a significant role in all of our lives.
And one way this retirement shift will affect us is due to their investments…
One might think, according to the advice of most financial advisors, that these new retirees will begin to shift from the stock market to less risky investments.
That leads some people to suspect that the stock market might fall due to less money flowing into retirement accounts and 401(k)s – and more money flowing out.
But is this picture really as simple as it seems?
Required Minimums
There are a few reasons I don’t believe this situation is as much a threat to the markets as some might think.
One of the factors we should consider when looking at mass baby boomer retirements is the Employee Retirement Income Security Act (ERISA).
ERISA was established in 1974 as a tax and labor law. It establishes minimum standards for pension plans, and it contains rules on the federal income tax effects of transactions associated with employee benefit plans.
I know that’s a mouthful, but stick with me…
If someone has a 401(k), pension plan, deferred compensation plan, or profit-sharing plan, then their account falls under ERISA.
So why do I bring it up?
In short, ERISA requires that a certain amount of these investment accounts be held in stocks and puts a minimum in place for the number of stocks, real estate, mutual funds, and money market funds these accounts must hold. What that amount is depends on the account.
It basically puts a natural floor of buying in place, even after people retire. Your pension fund will still be buying stocks, even if you’re now retired and drawing on it for income.
So these retirement accounts must hold a certain amount of their assets in stocks – no matter what.
But what about baby boomers’ other brokerage and investment accounts?
What If Boomers Pull Their Money Out?
As I mentioned earlier, retirement advice often begins to shift asset allocations away from stocks and into safer assets or cash to fund people’s lifestyles.
So if boomers are retiring, does that mean their money isn’t going to be invested anymore?
Here’s where some perspective is key…
The simple answer is that our asset allocations typically shift over decades if not years.
Conventional financial planning states young single earners can absorb more risk with a farther horizon towards retirement. So they typically have a higher concentration in stocks and lower concentration in bonds and fixed-income investments.
But the closer we get to retirement, typically the administrator of the plan or the financial advisor will gradually shift away from risk toward “safer” investments along the way.
In other words, retirement doesn’t mean we’ll see a sudden, drastic shift out of stocks.
It’s been happening like a slow-moving glacier over the course of each worker’s entire career. So when it’s retirement time, there’s no sudden pressure to sell stocks.
On top of all that, people aren’t suddenly cashing out their whole retirement accounts and running off to the Caribbean with duffle bags full of cash.
Most retirees live off of two things:
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Money they pull from their accounts to live on
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Interest and returns that their investment accounts generate… And to earn a return on your account, your money has to stay invested.
In fact, only 21% of retirees surveyed reported feeling comfortable pulling more than the minimum out of their accounts.
When you’re retired, you must pay income tax on what you take out. So there’s a real incentive for most people to sell as few of their nest eggs as possible each year.
This natural reluctance is also why there is a required minimum distribution (RMD) that you have to take (and be taxed on) once you turn 72.
Most people take just the minimum, so you don’t have to sell your whole portfolio and pay taxes on it. And by most people, I mean 68% of retirees are doing exactly that.
And there’s one more reason we don’t have to worry about capital evaporating from the stock market…
Prime Earning Years
Millennials have just entered their prime earning years. The millennial generation born between 1981 and 1996 is the largest generation alive on the planet right now.
There are 1.8 billion millennials around the world, equal to 23% of the global population.
Over 73 million of them live in the U.S. Plus, there are nearly 68 million Gen Z-ers in the U.S. coming up the ranks as well.
This means that investment and retirement accounts are going to be filled with their 401(k) contributions, employer matches, and other investment capital as these professionals begin ramping up their retirement accounts – or begin to enter the workforce, in the case of Gen Z.
So any reduction in capital in the markets from boomer retirements won’t be a huge problem in the coming years. Any disruption will swiftly equalize as the generations adapt to their new position in the economy.
At the end of the day, people still retire, they still invest, and they still grow their nest eggs.
The millennials are just the ones in the driver’s seat now.
And there’s always a new generation next in line to take the wheel…
Talk soon,
Jason Bodner
Editor, Outlier Insights
P.S. I hope everyone enjoyed today’s topic. If you have a question that you’d like me to answer in a future essay, please write in! You can send any messages to [email protected].