19 Aug 2009

Changing Demographics Will Wreck Social Security and the Stock Market

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During a meeting with my co-author Carlos Lara yesterday, he raised a point that is obvious but that I had never considered: As the US population ages, this will exert huge selling pressures on the US stock market. Why? Because 401(k)s and other IRS-created retirement vehicles have a built-in exit point. As Nelson Nash explained in his recent LRC piece:

According to all Tax-Qualified Plans, when one turns 70½ you must begin to take income (taxable) from your plan. That means you have to sell your stocks or mutual fund shares. Pray tell, who will you sell them to? Where are the buyers in the next generation?

Everyone see the problem? If the age cohorts were always uniformly distributed, it wouldn’t matter. As one group hit 70, they’d start taking their mandatory withdrawals from their 401(k)s and other holdings. But at the same time, a fresh group of comparable size would enter the workforce, and they would start socking money away into their own (tax-deferred) retirement accounts.

But that’s not going to happen over the next few decades. As we all know in the context of Social Security’s insolvency, the US age distribution is becoming lopsided toward the elderly, as the Baby Boomers move through the age distribution. The first Boomers were born in 1946. Right now they are 63 years old. That means in seven years a wave of stock selling will ensue, due to the arbitrary tax incentives of government-sponsored retirement plans. But of course, smart investors will anticipate this, and start unloading their shares in six years. But the super-smart investors will anticipate this, and start unloading their shares in five years…

A Robert Lucas would tell us not to worry, that the market has already priced all this information in. I doubt it. To see just how significant the demographic shift will be over time, check out this cool link, where the age distribution morphs on your screen (HT2MR).

Here’s another article making the same point I am here.

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