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Swelling retiree ranks create negative impact on returns

  • Some hold that as huge numbers of baby boomers retire, they'll pull money out of 401(k) plans for spending — and thereby cause returns on investments to plummet.
  • However, retirees — wealthy or not — have actually proved to be frugal, but that won't help asset rates rise, either.
  • Demographic factors are behind slower than expected economic growth since the last recession, but it's not certain whether or how strongly it will continue.
  • A key unknown is whether Social Security benefits will be reduced.

Baby boomers have been blamed for a long list of societal ills almost since the first member was born in 1946. A potentially decades-long decline in investment returns is one of the most serious charges to be laid at the generation's doorstep, and some experts think we may already be in the middle of it.

Historical returns for a balanced portfolio have averaged about 8 percent annually. Between 2005 and 2050, according to a 2009 analysis, investment returns are likely to decline by about 0.9 percentage points. Economists generally agree on the driving force — the retirement and resulting change in spending and saving patterns of America's largest generation — but not the mechanism of the decline. The prevailing theory guesses retirees will depress returns by pulling money out of their 401(k) plans so they can spend it in retirement.

A popular theory has it retirees will depress market returns by pulling their savings out of 401(k) plans so they can spend more.
Pascal Broze | Getty Images
A popular theory has it retirees will depress market returns by pulling their savings out of 401(k) plans so they can spend more.

"The assumption is that our wealth does us little or no good after we're dead," said Steven Sass, a research economist at the Center for Retirement Research at Boston College and author of a recent research brief on the effect of surging retirement on investment returns.

However, Sass says these assumptions are too simplistic and also at odds with data on retiree spending. Rather than devoting their funds to traveling, buying second homes and otherwise further gilding their golden years, he says, retirees tend to be frugal. That's especially true of the wealthy who hold most retirement assets, but less-wealthy retirees worried about running out also restrain expenditures.

"The elderly don't like to spend down," Sass said.

So if retirees don't spend their savings, wouldn't that help returns? Not according to this model. In the short term, retirees who hang on to investments while younger folks are saving for retirement will see rising asset prices, Sass said. Long-term, however, the greater supply of savings will reduce returns.

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This effect will be aggravated by minimal labor force growth as boomers stop working. A stagnant labor force will restrain economic activity and the need for money to fund roads, shopping centers and factories. And that, according to this model, which is gaining currency with economists, will further reduce returns.

"The demand for investment dollars could ease at a time when a high level of savings is competing for investment returns," said Russell Price, senior economist at Ameriprise Financial in Minneapolis. "Ultimately, this scenario would lower the expected returns overall."

Price says this scenario is already playing out, and that demographic factors are behind slower than expected economic growth since the last recession. However, it's not certain whether or how strongly it will continue. A key unknown is whether Social Security benefits will be reduced.

"Innovation, productivity, structural factors and policies, as well as many other factors, can overcome demographic considerations over very long periods of time," Price added.

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Assuming you buy into the low-return future, what should you do? Save more, is one popular recommendation by financial advisors. But savers may also be able to beat the overall downward trend of the markets by, for instance, savvy sector investing.

Tim Estes, a certified financial planner in Fort Worth, Texas, likes industries that should prosper as the population ages. "One of the big ones is long-term care, nursing homes and assisted living," Estes said. "They can't build them fast enough."

While advanced nations mostly also have aging populations, many emerging nations are at a point when more people are saving for retirement. So international investing may soften the blow, says Katherine Kraeblen, a certified financial planner with The PNC Financial Services Group in Raleigh, North Carolina.

"I wouldn't be too terribly worried about the baby boomers depressing the stock market." -Katherine Kraeblen, certified financial planner with The PNC Financial Services Group

"Demand for U.S. equities isn't just coming from U.S. investors," Kraeblen said. "We invest in foreign stocks, and foreign investors invest in U.S. stocks."

Another possible ace in the hole for U.S. markets is America's appeal to working-age immigrants. In 2015, more than 1 million people became lawful permanent U.S. residents, according to the Department of Homeland Security.

"This is the kind of thing that helps keep the economy growing and the market strong," Kraeblen said.

Retirees ultimately may cope effectively with lackluster market returns by tapping home equity, downsizing and wisely using long-term care insurance and annuities, suggests Sass at the Center for Retirement Research. Working longer before retirement is another promising solution, and PNC's Kraeblen said that today's retirees seem to be doing that, which might temper the effect of their mass retirement by spreading it over a longer span of years.

Generally, investment advisors recommend staying the course. Kraeblen suggests future retirees may be more heavily weighted in equities in order to improve returns over fixed-income investments. But she does not advise radical changes.

"I wouldn't be too terribly worried about the baby boomers depressing the stock market," Kraeblen said.

One theme of the long-term investment return scenario is that, whatever negative influences they've had, the baby boomers have provided solid support to the previous generation of retirees.

"We've done a great job," said Sass at the Center for Retirement Research. "We've lived in the golden age of retirement, and the elderly have never had it as good as they do now.

"The question is, can we maintain that as we shift from employer pensions to 401(k) plans?"

— By Mark Henricks, special to CNBC.com

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