A Word to the Wise Investor: Demographics

Boomers' sheer numbers and increasing longevity will impact investment trends, from school bonds to health care and the stocks of RV outfits

By Palash Ghosh

Like the rest of the developed world, the U.S. faces some dramatic demographic changes, which may drastically impact the government's budget, the fate of retirement assets, and the performance of financial markets, including the behavior of the investment community. These demographic shifts center on the aging and imminent retirement of the baby boomers -- the 80 million-or-so Americans born between 1946 and 1964.

As boomers enter their twilight years, the next group coming up, Generation X -- about 75 million Americans born between 1961 and 1981 -- may be unwilling or unable to support the immense financial and health-care needs of their elders.

A rapidly aging population, combined with a falling number of active workers, would represent an unprecedented tandem in U.S. history, and could significantly change the way we invest and what we invest in. Doomsayers have forecast that this confluence of events could bankrupt Social Security and exhaust Medicare and Medicaid long before the middle of the 21st century.


  Neil Howe, an economist who has written extensively about future demographics, says boomers are entering their peak earnings years, and that this is largely driving the economy. "After the oldest boomers become eligible to retire on Social Security in 2008, a steadily growing share of this large generation will be selling assets and consuming less," he predicts. "This could spell trouble for the stock market and the economy. A smaller and more income-strapped Generation X may not be able to pick up the slack."

What does this mean for stock investors and mutual funds? It's very difficult to say, since mutual-fund managers and market participants don't invest with a multi-decade perspective. Most investors don't look beyond the next year or so for their portfolios.

"The impact on mutual-fund investing will probably not be as severe as other prognosticators are warning," says Louis Harvey, president of Dalbar, a Boston-based mutual-fund consultant. The reason, Harvey says, is that retirees are beginning new careers instead of leaving the workforce altogether (See BW, 7/25/05, "When You Still Want to Work").


  "I see a regeneration and a reentry into the workforce of these 'retired' folks, which gives them another 25 years in the labor force," Harvey predicts. "The impact on investing is that we won't see a sudden shift from accumulation to withdrawal. Rather, we'll likely see a gradual shift, a stabilization. Most retirees will keep their money in the market in one form or another."

However, Harvey says that since mutual funds became an investment for ordinary people only in the 1980s, "We don't really have enough history to make any determinations on future fund-investor behavior."

In many cases, retirement is being postponed, people are living and working longer, says Charlie Mayer, director of U.S. portfolio management at Pioneer Investment Management. "With tax laws changing and interest rates so low, many older investors could substitute equities for conservative bonds in their retirement portfolios," he says. "Baby boomers, in particular, have to not only take care of their children, but also their parents. But it's up to each individual's own risk profile to see how they can cope with retirement."


  Howe strikes a more admonitory tone. "Baby boomers are worried that there will not be enough Social Security for them, and are worried about their overall financial security," he says. "They are uniquely lacking of confidence regarding their retirement. Boomers have trouble getting beyond their early expectations that 'the system' would somehow always take care of them. They had hoped they wouldn't really have to take personal responsibility."

On the other hand, Howe points out, Generation X seems to have more confidence in their future retirements and financial health. "Gen-X never trusted the system, and they know it won't be there for them," he notes. "As such, they're making alternative arrangements for their futures."

As far as the behavior of investors of different generations, Harvey notes that no generalizations can be easily made. "The theory of financial planning holds that the older one gets, the more conservatively one invests, but this is not true in practice," he says. Financial planners have a rule of thumb: your exposure to bonds should match your age, he says. If you're 40 years old, he explains, your portfolio should be 40% invested in bonds, and so on.


  "In practice, the younger investors -- Generation X -- tend to use fixed-income investments because they're not really paying attention to their assets," he says. "They stick their money in the bank or a CD, walk away, and don't manage their investments. Serious investors, regardless of age or generation, tend to be people who have accumulated, or inherited, some wealth."

A handful of mutual funds, like the $396-million AIM Dent Demographic Trends Fund/A (ADDAX ), were devised specifically as a play on changing demographics. The portfolio was based on the ideas of economist Harry S. Dent, who has identified a number of generational trends, and the sectors expected to profit from them.

In a nutshell, the fund focuses on the information-technology, financial-services, consumer-discretionary, and health-care industries. These are typically the businesses most widely regarded as benefiting from population trends, but the overall picture is extremely complex and subject to much conjecture. AIM Dent Demographics Trends Fund, which has performed poorly, is about to be folded into AIM Weingarten Fund/A (WEINX ).

Some experts speculate that the graying of America will spell big profits for the health-care sector. However, Rodney Hathaway, co-manager of the Heartland Value Plus Fund (HRVIX ), doesn't necessarily agree. "A large pool of elderly retirees will require all kinds of medical care, and the product pipeline of the biotech and pharma companies may be there to meet this huge new demand -- but who will pay for it all?" he wonders. By Palash Ghosh


  Hathaway notes Medicare is "on the verge of bankruptcy" and employers like General Motors (GM ) are having trouble paying pension and health-care costs. In this changing marketplace, he believes many health-care companies may see "either squeezed margins or lower-than-expected utilization, which may cause them to cut pricing. It's a complex and murky picture."

Instead of looking at broad sectors that might benefit from future trends, Hathaway suggests investors should consider a company's long-term business strategy, or explore niche subindustries. "For example, companies that focus on lowering health-care costs or those involved with preventative medicine might make a good long-term investment," he suggests.

Some mutual funds are demographically oriented due to the very nature of their investment mandate. For example, the Aquila Rocky Mountain Equity Fund/A (ROCAX ) was formed to take advantage of the extraordinary population growth of the Rocky Mountain states. "In the 1990s, according to the U.S. census, the average Rocky Mountain state grew 29.6% in population, while the remainder of the country gained only 9.8%," says Barbara Walchli, the fund's portfolio manager. "Both retirees and younger people are moving here, attracted by the lifestyle and lower costs of living, and they are followed by companies and venture capitalists."


  Walchli notes that most companies in the region tend to be young and entrepreneurial, mostly micro-, small-, and midcap stocks with high-growth forecasts. One particular industry that's a direct demographic play, Walchli says, is the burgeoning casino/gaming sector, particularly in rapidly growing Nevada. "With a large number of baby boomers entering their peak earning years and possessing substantial spending power, casinos, hotels, and other leisure/entertainment businesses tend to flourish," she says.

Another sector that some think might benefit in the coming years: financial services -- particularly companies devoted to managing retirement assets. "Baby boomers are keeping their retirement savings in traditional pension plans, including 401(k)s," Hathaway says. "But as they retire, they'll need a way to optimize that nest egg to last them longer, since they will live much longer. Thus, investment-advisor companies will likely be in great demand."

Hathaway also believes online companies and Internet service providers will continue to grow in popularity, and will serve a plethora of different needs -- many of which probably haven't even been recognized yet. "Internet retailers likely are here to stay," he says, and likely to keep growing since the 20s and 30s age group are deeply committed to the Internet.


  Others believe that a large pool of affluent retirees will be a boon for the travel/leisure industry, specifically benefiting airlines, high-end hotels, cruise lines, casinos, gambling, health clubs, etc. Within the travel sector, Hathaway thinks the motor-home industry will benefit directly from aging baby boomers retiring, since they seem to enjoy touring around the country in RVs.

Certain Old Economy industries, which most investors have given up on, may also benefit from demographics, Hathaway adds. "For example, consumer products are getting more disposable and are packaged in smaller individualized quantities," he says. "This means more packaging, more plastic, more aluminum foil, more paper, etc. This is potentially good for paper, plastic packaging, and aluminum companies, among others."

Demographics can also play a role in bond investing. Zane Brown, director of fixed income at Lord, Abbett & Co, notes that municipal bonds are an extremely attractive investment now, with the yield on munis now matching those of Treasuries.

"With muni bonds, you currently have great demand and limited supply, and this has been driven by the baby boomers," Brown says. "When the boomers moved to the suburbs, there was a huge development of infrastructure, including schools, bridges, water-treatment plants, etc. All this construction required a heavy supply of muni bonds. But now, all the infrastructure is pretty much in place, and the population of the new generation of kids is falling."


  Brown notes that the high school graduation class of 2006 will be the largest for the next 15 years, ensuring that the supply of school-related municipal bonds will remain limited.

While certain future trends and behavior patterns may be predictable, it must also be remembered that baby boomers represent a wide, diverse cross-section of the population with vastly differing lifestyles, attitudes, and spending power. Generally speaking, the older boomers, who are now on the verge of retirement, have done better financially than younger boomers. As a result, the boomers' spending habits, and the force with which they spend, will vary somewhat over time.

Ghosh is a reporter for Standard & Poor's Fund Advisor

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