Boomer market meltdown?

Should you invest differently given the impending retirement of tens of millions of baby boomers? This is a question I’ve received from advisors and investors in recent weeks, and one which, quite frankly, I’ve given little thought to throughout the financial crisis. (It always seemed like a topic of conversation when the Dow was at 14,000 and not at 7,000.)

But some investors, rethinking their allocations in a post-financial-crisis world, are asking whether they should fundamentally take less equity risk because of an impending wave of boomer-driven selling. You are familiar with the basic argument. As boomers approach and enter retirement, they begin selling the equity holdings they’ve accumulated during their working years. This liquidation of stocks will put long-term pressure on market prices, leading to mediocre returns.

There is some legitimate fear here. As I’ve mentioned in other contexts, public surveys show that retired individuals are more risk-averse. Yet for a variety of reasons, I’d suggest that any boomer-related selling will be a slow and gradual process. More likely than not, returns are likely to be driven by the enduring economic fundamentals that typically influence long-term market results, and less by demographic changes.

The first reason not to worry is that aging boomers are more likely to continue to hold higher levels of equities than prior generations. Why? Mostly as a result of experience, habit, and inertia. The boomer generation grew up alongside an expansion of equity holdings among U.S. households (mostly because of 401(k) plans) and that is likely to lead to some continued equity exposure in retirement, even if at somewhat lower levels. Boomers are also (on average) better educated than their parents, and it’s true that better educated households are often willing to take on more market risk.

A second point here is that long-term demand for U.S. stocks is still substantial. The Gen X, Gen Y, and Millennial generations number in the tens of millions, and will approach and reach their peak savings years while the boomers are in retirement. Growing affluence in emerging economies will also boost demand for U.S. equities from abroad. (The latter is sometimes called the China or the Malaysia or the Brazil effect—depending on your emerging market of choice—namely, that rising wealth levels abroad will lead to rising demand for U.S. equities.)

Third, it’s worth recalling that the baby boom generation spans nearly two decades. Its members will retire gradually, over time, and not all at one precipitous moment. Nor it is likely that, come retirement date, boomer households will make a sudden lurch out of equities. Portfolio changes are rarely step-function-like.

A final point: Most equities are held by the truly affluent. (About one in ten U.S. households own as much as 80% of all equities.) Those households will continue to hold U.S. and foreign equities (along with bonds, real estate, and business interests) as essential portfolio holdings, regardless of the long-term aging of the population.

In the end, if you are thinking through how to allocate assets, the lesson, it seems, would be to focus on the underlying economic fundamentals of the global economy, and balance those potential rewards against the likely short-term risks. With two bear markets in less than a decade, the risk-return balancing act should be easier to conceptualize today (and have more emotional resonance) than in the past.

The generational changing of the guard is a factor in all of this, but in the end it seems not a substantial reason to bias your portfolio against a given level of equity exposure. Better to focus on the lessons we have learned in the past two market declines: Stocks can fall by half (or more) in a pretty short time frame, and over long periods, they can often underperform or only match the return on high-quality bonds.

Notes: All investments are subject to risk. Past performance is no guarantee of future results.