Investors Needn't Fear The March Of TimeChristopher Farrell
Remember Limits to Growth, the 1970s jeremiad by Donella and Dennis Meadows? Their computer model predicted catastrophic shortages of oil, food, and other commodities if economic and population growth remained unchecked. Now, oil prices are lower than they were in 1974, adjusted for inflation, and commodities are plentiful and cheap worldwide.
Today, the popular polemic would be Malthus Visits Wall Street. Simply put, there are too many baby boomers, and when elderly, they will overtax the economy's resources. Real home prices will fall in coming decades with hordes of elderly home sellers and not enough young home buyers. When they retire and draw down their private pensions, the massive asset sale will depress stock and bond values, leaving boomers with less money in their golden years.
Yet investors shouldn't fear the march of time. The longer investment horizons are, the easier it is to ride out the swings of the business cycle.
NEW DEMAND. Over the past several years, home prices in some markets did plunge, and a lot of upscale houses went unsold. Yet overall, housing is still an appreciating asset, and real home prices are up. From 1850 to 1992, real estate's after-inflation return was 2.5% a year, a figure based on a study of 16,000 unencumbered land sales in Middlesex County, Mass., says Karl E. Case, economics professor at Wellesley College. Immigrants, who are flocking to the U.S., will be a source of new home-buying demand, adds Anthony Downs, real estate economist at the Brookings Institution. And on the supply side, homebuilders will cut back on projects if demand slackens.
The specter of a pension-asset implosion is implausible, too, largely because of the move toward market economies around the world. The spread of private property rights and openness to the world economy is encouraging vast amounts of capital to flow across borders. By the time boomers need to sell, markets will be far more international. Says Jeremy J. Siegel, financial economist at the Wharton School: "There will be a lot of foreigners to buy U.S. assets in the 21st century."
The outlook for long-term investors appears appealing, especially for equity investors. Stocks are both a safer asset than bonds and a higher-return investment for periods longer than a decade. From 1802 to 1992, U.S. stocks had an average real return of 6.7% a year vs. 3.4% for bonds, according to Wharton's Siegel. Higher U.S. productivity and world-class technological innovation give the U.S. every chance of regaining global industrial leadership. And less-developed nations joining the free-market world give the global economy an unprecedented degree of diversity, which means a less risky world economy, says Peter L. Bernstein, a New York-based economic consultant.
Bonds should also retain value, and fierce domestic and global competition should keep inflation at bay. The bond-market vigilantes--and their public representatives, central bankers--will make sure rates surge at even a hint of inflation. And bonds do well when inflation is constrained. In the last third of the 19th century, with negligible inflation, bonds had a total real return of 6.57% a year (and stocks, 8.5%). By contrast, from 1966 to 1981, when consumer-price inflation averaged 7%, bonds had a total return of -4.2% (and stocks -0.4%).
STRIKING A BALANCE. The most critical decision to be made by anyone saving through a 401(k), individual retirement account, or other such plan is to participate. The next decision is the balance among stocks, bonds, real estate, and other assets. Many people are too conservative in their investment choices, unwilling to put their nest egg at risk to the swings of the stock market. Most economists agree that young people should allocate as much as 80% to stocks and no less than 50%. Older investors typically invest 50% or less in stocks. Yet with average life expectancy of about 17 years after age 65, stocks still have a place in an investment portfolio even after retirement.
What investors really have to fear is not the inevitable swings in the markets but that policymakers will change the rules of the game on them. Over the past decade, government policymakers have steadily limited the tax-advantaged preferences in employer-sponsored pensions and IRAs to trim back the federal budget deficit. Despite all the fearmongering on Wall Street, the underlying message is right: People need to save more to protect themselves from political meddling.