Dying To Get Out

Will baby boomers cashing out crash the stock market?

With the creation of tax-deferred retirement accounts in 1957, Canadians discovered a new source of anxiety: the (depressing) state of their retirement portfolios. Too often neglected, however, is that the move to mutual funds from GICs through the '80s and '90s became a shared exercise in prosperity, as demand for equities pushed up prices. So instead of fretting, let's all celebrate.

OK, now stop celebrating. There's a dark side to the RRSP upside: What happens when baby boomers draw down their retirement accounts? That they will draw down those accounts is hardly a matter of debate–few will be able to maintain their desired lifestyles on dividend and interest payments alone. Some, at least, are going to cash in their holdings. Of course, this happens all the time. But the problem now is that the first of the baby boomers–a significantly large demographic cohort–are set to begin retiring around the end of the decade, and that will lead to an increase in the equity sold back into the market. Assuming the laws of supply and demand still hold in 2011, a drop in value generally for the market seems inevitable.

Are boomers in for a less comfortable retirement than they thought? “It's a big question in academia, at least in the U.S., where the question of social security is hot,” says Andrew Ang, an associate professor from Columbia Business School. And the answer? Not surprisingly, economists are split.

On one side are those like Yale's John Geanakoplos, who thinks demography plays a large role in market movement. In a recent paper, he divides postwar market movements into three periods: the boom years, 1945-66; the bear market of the '70s and early '80s; and then the return to the boom in the mid-'80s that extended through the '90s. Geanakoplos points out that while reasons for the boom years are easy–technological innovation and the expansion of retail investor participation among them–periods of declining stock prices are harder to explain. He suggests that the common thread might be demographics. Live births seem to go through an alternating 20-year cycle; the low birth rate of the Great Depression was followed by the baby boom of the postwar years, followed by the baby bust of the 1970s–periods that correspond roughly to the cycles of the market. “It seems plausible,” Geanakoplos writes, “that a large middle-aged cohort seeking to save for retirement will push up the prices of these securities and that prices will be depressed in periods when the cohort is small.”

Others, however, contend that any effect will get washed away in the interplay of myriad other forces. “There are doomsayers, but quantitatively I think the effect will be small,” says Ang, who along with fellow researcher Angela Maddaloni wrote a 2003 paper titled “Do demographic changes affect risk premiums?” for the European Central Bank. They found empirical evidence of an effect, but suggest it's going to be hard to predict. In the same vein, a widely read paper by MIT economist James Poterba calculates that the effect may total half of one percentage point over 30 years. That would shave a total of 14% off a portfolio–hardly a meltdown. It wouldn't even turn a bull market into a bear. And Poterba suggests trends like immigration and international capital flows from the developing world could counter any market effect.

One theory holds that newly born investors in developing countries will pick up any slack in demand for stocks–for them, a sell-off in North America would provide a huge buying opportunity. In any event, skeptics argue, the many factors involved make it nearly impossible to predict with any confidence what's actually going to happen.

In a sense, this is an issue that has less to do with market dynamics and more to do with elected officials, says Ang. Immigration controls and attempts to bring all immigrants into “the system” in the United States will have a big impact on how the demographics/market story plays out. “It's not so much an economic but a political question,” Ang argues. “My honest opinion is that there will be some effect, but equity markets are highly volatile and it's hard to predict anything out five to 10 years. I'm not arguing that this effect isn't there, but there are so many other factors in play it's hard to say what any effect will be.”

So stop worrying: doomsday is an unlikely scenario. Probably.