Demographics and equity returns: A far-fetched horror story

19 March 2018 | Joe Davis


Happy retirement cake image

At a recent event, someone asked me, "Will the baby boomers' reduced equity exposure be offset by the millennials' equity investing?"

If you wanted to write a stock market horror story, the plot might look something like this: As baby boomers retire, they will begin selling stocks. The millennial generation, burdened by student loans and traumatised by the dot-com bubble and global financial crisis, will avoid investing in stocks.

The result: Stockmageddon!

Boomers' market footprint is not a systemic risk

With the 65-and-older percentage of the population in the United States and other Western countries ever growing, this potential scenario has garnered quite a following. When Vanguard looks at the plot, however, holes begin to emerge. Here are a few:

  • A 2006 analysis by the US Government Accountability Office of Standard & Poor's 500 Index returns from 1948 through 2004 found that demographic variables accounted for less than 6% of equity market return variability. This finding indicates that macroeconomic and financial variables far outweigh the impact of demographics.
  • The baby boomer generation spans almost 20 years; therefore, any asset rotation out of equities will be gradual.1
  • According to the US Federal Reserve Board's Survey of Consumer Finances, the 45 to 64-year-old age group owned 50% of all US equities in 2016. This was almost identical to the 51% average held by the same cohort over the previous 27 years. During that time, the number of 45- to 64-year-olds increased from 19% to 26% of the overall population. In other words, even as the proportion of pre-retirees increased, their stock market footprint did not.
  • Foreign holdings of US equities as a percentage of total US equity market capitalisation rose from 7.2% in 1988 to 22.6% by 2016. Even if there were a connection between US demographics and domestic stock market returns, international investors would dampen the impact.2

No significant relationship exists between the changing proportion of US retirees and long-term equity market return variability

Stock market return variability since 1936

Notes: The US total stock market is represented by a spliced benchmark composed of the following indexes: Standard & Poor's 90 Index (January 1926 through March 1957), S&P 500 Index (April 1957 through December 1974), Wilshire 5000 Index (January 1975 through April 2005), MSCI U.S. Broad Market Index (May 2005 through June 2013), and CRSP U.S. Total Market Index (thereafter). The historical data for the US total resident population ages 65 and older (January 1926 through July 2017) were derived from Moody's Analytics database, available at Sources: Vanguard calculations, using data from US Census Bureau and Moody's Analytics.

Don't believe everything you read about millennials

Chapter two of the story centres on the notion that, burdened with student loans and shell-shocked from the dot-com bubble and global financial crisis, the millennial generation is risk-averse and reluctant to invest in the stock market. When Vanguard analyses the data, however, this narrative arc appears a bit far-fetched.

  • The ratio of debt payments to family income for heads-of-households younger than age 35 gradually declined from 18% in 1989 to 14% in 2016. The drop resulted from a combination of lower overall interest rates and the shift in debt composition from consumer credit to education. This undermines the theory that millennials' student loan obligations will constrict investable funds.3
  • The invention and widespread adoption of automatic enrolment in employer-sponsored retirement investing plans has increased participation rates in all age brackets. Participation in the 25-to-34 age group rose from 57% in 2005 to 74% in 2015.4
  • The remarkable popularity of target-date funds has improved investors' asset allocation strategies. In 2005, the 25-to-34 age group held 78% of retirement plan assets in equities. By 2016, that figure was 86%. This is a noticeable progression towards the 90% equity allocation that most target-date funds recommend for younger investors, and it contradicts the notion that millennials are too risk-averse.4
  • The percentage of heads-of-households younger than age 35 holding stocks outside of a retirement account was 10% in 2016, slightly below the 11.7% average since 1987. This decline is more than offset by the growth in the cohort's retirement assets.3

A dubious tale

The scariest stories are those that are simple and believable. The plotline of an ageing population causing a sell-off in equities meets these criteria but collapses under empirical analysis. The demographic changes occurring in many Western countries will have noticeable implications for labour markets, public finance and political developments. However, Vanguard finds no credible evidence that demographic changes alone will negatively affect future stock returns.

Investors are well advised to ignore scary headlines and remember that an investment strategy focused on discipline, diversification, and patience continues to offer the clearest path to financial success.

1 Vanguard calculations, using data from the US Census Bureau.
2 Vanguard calculations, using data from the World Bank and the US Bureau of Economic Analysis.
3 Vanguard calculations, using data from the Survey of Consumer Finances (Federal Reserve Board, 2017).
4 How America Saves (Vanguard, 2017).

Important information:

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Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.