As the Baby Boomer generation nears retirement and draws down the assets they built in their working years, the retirement system in America and capital markets could go through some major shifts.
The Center for Retirement Research at Boston College (CRR) explores these concepts in several recent papers. One addresses the impact that shifting demographics can have on investment returns. The CRR notes, “Economic theory suggests that retirees draw down the assets they accumulated in their working lives, so a higher retiree-worker ratio reduces the supply of savings, thereby increasing investment returns.”
However, the paper cites research based on the Health and Retirement Study, which suggests that retirees draw down savings at a slower rate than expected, especially the wealthy, who hold the majority of assets.
So as retirees retain much of their wealth, a higher retiree-worker ratio instead leads to a greater supply of savings and a decrease in investment returns, the CRR suggests. However, the organization notes that the extent of this potential decrease is uncertain. Clearly, to the extent that investment returns decrease, workers would need to save more to maintain their standard of living.
The organization points out that the shift in employer plans from traditional pensions to 401(k)s means the savings of the elderly would increasingly be held in 401(k)s or individual retirement accounts (IRAs). A smaller chunk of pension benefits could mean a heightened focus on contributions toward 401(k)s and IRAs. The need to save more in these accounts could be heightened by a weakening Social Security system.
The CRR notes that “the demographic transition is largely responsible for Social Security’s long-term financing shortfall. If it reduces investment returns, it will also weaken the other component of the nation’s retirement income system—private saving.”
In a separate paper, the CRR analyzed one potential remedy to the Social Security downfall: dedicating a portion of the Social Security Trust Fund to stock investments. Of course, this would mean the system, which currently invests in only bonds, would take on additional financial risk it has never experienced before. However, the CRR points to research supporting the notion that stock investments could benefit Social Security.
The paper notes that average geometric returns for the S&P 500 have been 9.5% from 1928 to 2016, as opposed to 3.4% for the 3-month Treasury bill, and 4.9% for the 10-year Treasury bond, in that same period.
The study concludes that “both retrospective and prospective analyses suggest that investing a portion of the Social Security trust fund in equities would improve its finances; little evidence exists that trust fund equity investments would disrupt the stock market; equity investments could be structured to avoid government interference with capital markets or corporate decision making; and accounting for returns on a risk-adjusted basis would avoid the appearance of a free lunch.”
“How Will More Retirees Affect Investment Returns?” by the CRR can be found here.
“What Are The Costs And Benefits Of Social Security Investing In Equities?” can be found here.