(MoneyWatch) I get lots of questions from investors based on what they are reading or hearing in the financial media. A significant part of my time is spent calming down investors, assuring them that what they're concerned about is nothing more than investment "porn."
With the highly publicized aging of the U.S. population, among the questions I'm frequently asked is this: Will the large cohort of baby boomers who are set to retire likely begin to liquidate their holdings in the stock market and, at a minimum, shift more into bonds? And if so, won't this have a negative impact on future returns?
Don't confuse information with wisdom
To answer these questions we'll begin with understanding that investors shouldn't confuse information with wisdom (information from which you can generate "alpha" -- above benchmark returns). It's only unanticipated events that move markets, not those that are fully anticipated. Think of it this way -- if you know something (like a large segment of the population is nearing retirement), it's a virtual certainty that other investors also have this knowledge and have already acted on it. Thus, the expected impact of equity sales by retirees should already be reflected in today's prices. It's only if the level of equity sales is greater than expected that there could be a negative impact on future equity prices. And, it is certainly possible that sales will be less than expected.
It's also important to understand that what we often read, or hear, in the financial media, even if it sounds logical and the arguments are persuasive, may still be wrong -- as conventional wisdom often is. There doesn't seem to be any actual evidence supporting the conventional wisdom about the relationship between age and investment allocations. As Jim Davis of Dimensional Fund Advisors pointed out in a 2005 article, the evidence actually suggests that investors "accumulate equity positions during years of their greatest earning power and do not dramatically reduce those positions as they enter retirement." (Disclosure: My firm primarily uses DFA funds in constructing client portfolios.)
In addition, many people are now working well into what was traditionally considered their retirement years. Extending working years reduces the need to draw on portfolio assets.
More than just U.S. investors
Another important issue is that the U.S. equity market isn't solely dependent on domestic investors. The rapid growth of sovereign wealth funds and rapidly increasing income in developing markets could lead to increased demand for U.S. equities from non-U.S. investors.
Thus, it's quite possible that when a U.S. retiree is selling shares, the buyer will be a young software engineer from India or China. Even if U.S. retirees become large net sellers of equities, it doesn't mean that valuations will be negatively impacted. There might be offsetting increases in demand from other sources (see below for evidence supporting this idea).
Providing us with more insights into our question, Vanguard's research team recently examined the relationship between demographics and stock returns in a paper. Studying the relationship between an aging population and equity market returns across 45 countries, Vanguard found no statistically significant relationship. They concluded that there was no concrete evidence that the baby boomer retirement cycle will alter investors' views of U.S. equity market performance in the near to intermediate term.
The researchers also cautioned investors against making significant changes to their strategic asset allocations in response to the boomers' retirement. Vanguard cited a 2006 analysis by the U.S. Government Accountability Office of Standard & Poor's 500 Index's stock market returns from 1948 through 2004. It found that demographic variables generally accounted for less than 6 percent of stock market return variability -- far less than macroeconomic, financial and other unexplained variables.
Vanguard also offered the following insights:
- The baby boomer generation spans almost 20 years. Therefore, any asset rotation out of stocks should be gradual.
- The majority of investors who own traditional IRAs are unlikely to make a withdrawal from their IRAs before age 70 1/2, extending the asset ownership time frame.
- Of the baby boomers holding equity, assets are highly concentrated among the top 20 percent of boomers based on net worth. This group owns 96 percent of all the equities owned by the baby boomer cohort. And the top 5 percent owns 77 percent. The portfolio goals of this group are more oriented toward estate planning and intergenerational wealth transfers, making the continuation of equity ownership more likely.
- Overseas ownership of U.S. stocks increased by a factor of three over the two decades ended 2012 -- from just 7 percent in 1990 to nearly 21 percent by year-end 2012.