"Boomers Preparing to retire - Bond Funds Attracting Dollars. Is There a Connection?"

Sydney M. Williams

Thought of the Day

“Boomers Preparing to Retire – Bond Funds Attracting Dollars.

Is There a Connection?”

August 24, 2010

On January 1, 2011, the first of an estimated 77 million baby boomers will reach the age of 65, putting further pressure on already stretched retirement systems. During those birthing years for boomers, 1946-1964, the population of the United States increased from 141 million to 192 million, up 36%. (In comparison, over the nineteen years ending 2010 the population of the U.S. rose 23% to 309 million.) The authors of the Coming Generation Storm by Laurence J. Kotlikoff and Scott Burns write, “The portion of the population age 65 and over will nearly double over the next 30 years.”

Yesterday Bloomberg reported that investors over the past two years have “poured” $480 billion into fixed income mutual funds, a number that compares to the $497 billion that investors put into equity funds in 1999-2000, as stock markets were cresting. (In contrast to bond funds, investors have pulled $232 billion from equity funds over the past eighteen months.) What makes the bond inflows even more staggering is that aggregate bond mutual funds, ex money market funds, are about half the size of all equity funds. The pertinent question arises – given aging boomers and a rush to bond funds – are the two statistics related?

There is, of course, the natural tendency for aging investors to worry more about the return of their money than the return on their money. That line of thinking suggests that boomers, in their forties and fifties, were willing to speculate, but upon reaching their fifties and sixties became, naturally, more concerned about safety. That, perhaps, is the explanation.

On the other hand, the money flows may simply indicate the well-known lemming-like behavior of investors. Stock investors have fared poorly over the past decade and, as we all know, extrapolating the recent past is a common behavioral response. Between January 1, 1999 and December 31, 2000 when half a trillion dollars was invested in stocks the S&P 500 traded between 1229.23 and 1517.68. If the money had been invested at the average of those two prices, fund holders would have lost 23%, or $114 billion. This fact should give pause to bond investors and suggests some skepticism is warranted. Whether a “bubble” has developed I don’t pretend to know, but certainly there seems to be an element of complacency as to interest rates.

Structural aging demographics are a reality. State and local pension funds are underfunded. Social Security is expected to be drawing down assets in the next four or five years. Investors have seriously underfunded their own 401K and IRA plans and defined benefit plans are largely features of the past. The fact is there is not enough money. Economic growth is projected to be anemic and what growth there is will likely be led by exports, and the administration has still not signed two pending free trade agreements. Consumers are sensibly repairing their balance sheets and, while the savings rate has risen from 2% at the end of 2008 to 6.4% and the average credit score, as published by Equifax, is 704, the highest since 1998, that trend is likely to persist.

Aggravating the situation has been a leadership in Congress that seems oblivious to the on-coming problem. Social Security reform has been kicked down the road by members of both parties for years. The one President who attempted reform, George W, Bush, was vilified for his efforts. In retrospect, his recommendations and their timing would not have been auspicious, but they didn’t even get a debate. Congress is a body that responds to crises and has little interest, or ability, to anticipate events. Nevertheless, in three to four years Social Security will begin paying out more than it takes in. Besides denuding the agency of funds, it will have the effect of removing a natural buyer of U.S. Treasuries, not a positive for the direction of interest rates.

There are changes, reasonably simple ones that could be adopted. The age for receiving Social Security has been gradually increasing. That trend could be accelerated. Life expectancy has risen dramatically since Social Security was introduced in 1935, but that is primarily due to a sharp decline in child deaths. Life expectancy for a man who reaches 65 today is only three years longer than the man who reached 65 in 1935. The bigger problem is that the number of workers for every recipient has declined from 16 in 1950 to 3.3 in 2005. Other changes that would not be terribly disruptive would be to raise the annual earnings on which the FICA tax is assessed and employing some form of a means test. Liberalizing immigration policy for college and university graduates would attract a greater number of productive, young workers.

But I suspect the answer to the question in the title of this piece is no, there is not a connection between the flight to bonds and aging boomers. There may well be (and there should be) a greater desire for security as one ages; however, locking money up at two, three or four percent for twenty years does not necessarily assure security. Two percent inflation will reduce the purchasing price of the dollar by thirty percent over twenty years. And, despite all the noise about deflation, the CPI has risen three percent for the past twelve months. The race to bonds (and the dash from stocks) has been hastened by the sense, as Richard Thaler has put it, that “things feel more uncertain after bad times.”

Sadly, I suspect the dollars flowing to bonds does not reflect the considered and thoughtful decision making of soon-to-be-retired boomers, but rather the hype and antics of a crowd, trends that historically end badly.