Now there’s another reason to attempt to save more for retirement.
A brief from the Center for Retirement Research at Boston College that posed the question of whether a growing retiree population will exert an effect on investment returns came to the conclusion that the demographic transition would, indeed, create a drag on investment returns—even as those returns become increasingly important to the retiree population.
The question of the impact of a growing retiree population on the growth—or lack thereof—of returns on investments arises out of what the brief credits to economic theory: the suggestion that as retirees draw down their assets, a higher retiree-worker ratio reduces the supply of saving, thereby increasing investment returns.
Drawing on other studies that try to identify relationships in the historical record between changes in the age structure of the population and investment returns, the brief explored how retirees actually draw down their savings, and the impact that drawdown has on the supply of savings.
A large boomer contingent in the population, coupled with a shrinking of subsequent generations, the study found, is resulting in the ratio of retirees to the working-age population in the U.S. “grow[ing] rapidly through the middle of the century and more slowly thereafter as life expectancy continues to rise.” Other countries will also experience similar growth, with other countries by the middle of this century having similar or even higher concentrations of older people.
Those ex-U.S. demographics will affect capital flows into and out of the U.S. market, which in turn will exert an effect on returns. According to the brief, if the supply of savings rises relative to demand, the market-clearing return on savings falls and investors would get less income from interest, dividends or profits for each dollar invested.
On the other hand, if the savings supply falls relative to demand, savings can instead be invested in opportunities that offer higher returns.
But the demographic changes toward an older population mean, among other things, that the economy needs considerably less savings “to build new offices, factories, roads, and machinery than it had when the labor force was rapidly expanding,” says the study, adding that “[t]his decline in the demand for savings should lower investment returns.”
And while younger generations will be increasing both the supply of and demand for savings as they borrow, pay off debt and prepare for retirement, retirees will be drawing down their accumulated assets during retirement.
Studies using data from the Health and Retirement Study find that retirees draw down their savings at a much slower pace than suggested by the lifecycle hypothesis, which holds that households manage their finances to maximize utility over their lifespan—meaning that at the end of their lives, retirees would have nothing, or nearly nothing, left.
But in fact, retirees tend to hold reserves, the study finds, “primarily against the risks of outliving their savings or incurring high medical or long-term care expenses; a desire to leave bequests; and a general aversion by the elderly to drawing down their savings.”
The brief concludes that the demographic transition will likely put some downward pressure on investment returns, and although numerous factors will affect how strong that pressure will be, it says, “the decline in returns will require workers to save more to secure a given amount of income in retirement.”