Demographic changes in the United States and elsewhere have major implications for investment risks and returns. The combination of ever declining birth rates and the ever-increasing numbers of pensioners could have disastrous consequences for pension schemes and wealth creation. Therefore, any portfolio should be constructed with rapidly and substantially aging populations in mind. In this article we'll show you what demographic trend risks you should look out for and what effects they can have on your portfolio.
The Baby Boomer Time Bomb
American statistics given by the Centers for Disease Control and Prevention and the Administration on Aging warn of the frightening economic implications brought about by a rapidly aging population. By 2030, the number of people older than 65 is expected to increase to almost 20%, up from about 12.4% in 2003.
Some experts believe that this increase in the aging population will bring about a kind of "asset meltdown". This suggests that as the post-war "baby boomers" across the globe retire, they will convert their investments to cash in order to consume more. Simultaneously, the declining number of younger people, who in any event tend to buy rather than save, will further reduce the demand for all kinds of investments. (For more information, see Determining Your Post-Work Income and The Generation Gap.)
If this ticking time bomb scenario materializes, it would lead to a disastrous decline in asset values, extending from equities to bonds to real estate. A downward spiral in the capital and investment markets might last for decades.
Declining Investment in Equities
A study by researchers at Yale and the University of California indicates that population shifts can have a significant on investor behavior and equity values. The study says population estimates are relatively reliable and the group that generally invests the most (the older generation) will move increasingly into retirement and out of equities.
Indeed, these baby boomers were largely responsible for the "roaring '90s" in which equity investment was so profitable. The big investors, middle-aged people between 40 and 59, will decline in number constantly - at least over the short and medium term. This could leave a chasm in the demand for investments.
However, other research suggests that demographic trends only explain approximately 50% of equity values. There is evidence that the link between demographic trends, capital stock and equity trends is foggy. The Global Aging Initiative in Washington points out that "there has never been such a situation before", and predictions cannot be based on historical data. Also, it may be possible that expectations of such trends are already factored into equity prices. (For related reading, see The Stock Market: A Look Back and The Bond Market: A Look Back.)
People Moving Across Borders
Despite the challenges posed by an aging population, it is feasible that investment and consumer behavior may change for the better as a result of large influxes of immigration. A country such as the United States already has substantial immigrant flows, and will have less to fear than other countries with lower immigration rates. This trend may alter too, and the ultimate result depends partly on the extent to which influences from America or continental European countries spill over into the whole of North America.
Also, business cycle trends caused by different factors, such as entrepreneurship, investment or technological developments, may prove more significant than population changes. If such trends do prevail, they may cause strong economic growth. (For more insight, check out Understanding Cycles - The Key To Market Timing.)
In any event, these demographic trends not only create risks, but also opportunities. A clear implication is that investors may want to focus on emerging market economies and regions where demographic trends differ from those back home. (For more on this, check out What Is An Emerging Market Economy? and Finding Fortune In Foreign ETFs.)
Changing the Way You Look at the Future
Peter Temple, a writer for Interactive Investor in the U.K., draws further conclusions for investments in his article "The Long Term" (2002). He points out that the aging population and the pension time bomb create an obvious link to healthcare and financial services. However, he warns that this does not automatically mean that buying stocks from the major drug companies or health sector funds are smart investments - many are yesterday's winners.
Temple says tomorrow's winners will be companies that provide a variety of cost-effective services to elderly people and pensioners. These services extend from medical treatment, care homes, travel and anything else focusing on that specific target market.
The large number of pensioners who are relatively poor suggests that luxury services may not make the best investments. However, firms that produce medical and orthopedic products for the aging will do a roaring trade if prices fall over time.
It is also important to consider the risks associated with biotechnology sectors. These sectors can be extremely volatile and, therefore, they are not for low-risk investors - or only a small portion of a portfolio should be devoted to these funds and equities. (For background reading, check out A Primer On The Biotech Sector.)
Watch the Trends Closely
It is difficult to project prevailing demographic trends and their impact on future asset values. However, it is less difficult to monitor trends as they evolve and to rebalance your portfolio accordingly over time. Furthermore, such ongoing vigilance is essential in view of the major changes in the investment landscape that inevitably will result from the relationship between birth, death and what happens in between.
While no investor can accurately predict what the coming decades will have in store for the financial markets, there are few strategies to consider trying if you believe that the boomers' retirement could weigh on the marketplace.
For example, you should monitor population trends in any country in which you invest, particularly the developed regions like North America and Western Europe. If the investing public continues to decline, consider reducing your investment in equities in general. Certain types of bonds and other asset classes like hedge funds might provide lucrative alternatives.
At the same time, consider going overweight on budget healthcare and related services or products in these aging-population areas. Also consider investing more in equities and property in dynamic economies where populations are rising and remain youthful. Asia and parts of South America would be the prime targets in this case.
The Bottom Line
If you're concerned about this effect, you'll need to keep observing these trends so you can be prepared to act on them if necessary. Demography is always in flux, and so are the investment opportunities associated with it.
For additional reading, see A Guide To Portfolio Construction.