Why are we ignoring this issue?


April 7, 2021

My Dear Reader,

Recently I’ve been considering the impact of a number of growing trends within the financial field and in the socioeconomic world that I believe will create a problem that the United States has not faced in its history, and hopefully will not have to face again.

After World War Two, the United States experienced an influx of childbirth that created a generation much larger than their predecessors.  This generation was given the apt title of “baby boomers”.  During this generation’s “time in the sun”, they experienced the high interest rates of the 1980s, the digital revolution of the 1990s, and early 2000s before starting retirement en masse in 2012. In that time the landscape of personal finance and the savings of everyday Americans has not only stagnated but also the ability to grow wealth without the risk of volatile stocks began to vanish at the end of their working years.  Financial products such as bank CDs, money market accounts, and bonds saw their yields and respective rates of return drop dramatically over the past 30 years while government spending and inflation only increased.  This has unfortunately left many boomers at the mercy of the market, while simultaneously compounding the issue for the smaller Generation X and Millennials.  

Consider the English dilemma, as described by the Financial newsletter Fame & Fortune 

“Over the next three days, I’m going to show you why I believe the FTSE 100 stock market index and its counterparts in the developed world are likely in for an indefinite bear market. I’m talking about a steady downtrend in stocks, for the rest of your lifetime. Probably punctuated by a crash or two. And the occasional bear market bounce, of course. If that sounds absurd, please keep in mind it’s considered completely normal in the country where I’m writing this. After all, it has happened here. The stock market is down nearly 25% over the last 30 years. And that’s after a bear market rally of over 300% since 2009.”

What this is an indication of what is to come for the United States, which is always just a decade behind European trends, is that as a large population ages with a smaller replacement population, markets can be adversely affected.  In the same article, Fame & Fortune continues outlining the impact;

“Do you see how the overall demand and supply of stocks is determined by the size of age cohorts? The number of middle-aged workers (investment buyers) relative to the number of retirees (investment sellers) determines the demand and supply of investments. The good news is, demographics are predictable. The number of buyers (demand) and the number of sellers (supply) is easily calculable and known in advance. Therefore, you can predict the supply and demand for stocks. And that allows you to make reasonable predictions of prices in financial markets. At least their direction over longer periods of time.”

This outlines some of the problems with the market coming up.  While demographics clearly influence market prices, the impact on the sequence of returns compounds the issues for the following generations.  For those who are unfamiliar with what the sequence of returns is, it is the principle that partially determines how successful a retirement plan is based on the order in which money is withdrawn from the account concurrent with a market return.  In practice, here’s what it looks like:

In the standard sequence of returns, the original investment of one million dollars earns more money over time, despite the one hundred thousand dollars per year withdrawal.  However, if we simply flip the sequence of returns, though the average rate of return stays the same, the prospective client actually loses money:

In an era of a potential market downturn, driven by changing demographics, the sequence of returns could end many retirement plans prematurely without changing the rate of returns per se.  The greatest worry here is that there is little the financial industry can do to change this trajectory other than focusing less and less on the market itself.  Which could be nearly impossible with safe positions eroding under other factors.

To Your Creation and Potential,

Kevin Prendiville