Boomers facing retirement challenges

A new white paper authored by JP Morgan has confirmed that while baby boomers may be retiring with a greater accumulation of assets than any earlier generation, they are still facing post-retirement challenges Benjamin Mandel writes. 

Baby boomer households have accumulated a median level of assets going into retirement that far exceeds the previous generation’s and will likely far surpass the next generation as well. 

We refer to this distinguishing level of attainment—and its potential reverberations in the economy, asset markets and future generations—as baby boomers’ “financial exceptionalism,” the product of equally exceptional demographics and economic factors. 

This elevated level of household assets is associated with a sizable segment of the population crossing the 65-year-old threshold over the next 15 years: between 2014 and 2030, the number of households in the 65 to 75-year-old range and the number over 75 years of age are projected to grow by 48 per cent and 79 per cent, respectively. They will bring a veritable tidal wave of assets with them into retirement. 

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“Exceptional” is, by definition, a relative term, and baby boomers’ financial exceptionalism is in contrast to the less favourable experience of other generations. Our analysis shows, for example, that in 2013, households 29 to 48 years of age, falling within our definition of generation, had a median household net worth 20 per cent less than that of baby boomers at a roughly similar age 20 years ago. What’s more, gen-x’s five-year average annual income growth, return on assets and savings rate in 2013 were below those of their baby boomer counterparts at a similar stage of their life cycle. 

It is difficult to overstate the demographic exceptionalism of the US baby boomer generation.

This paper documents the extent of baby boomer exceptionalism by looking at the evolution of the generation’s household balance sheets. We evaluate and compare the experience and retirement prospects of those currently at or near retirement age with those of today’s younger generations. Finally, we derive potential implications for asset markets as baby boomers enter retirement en masse. Among the first questions we seek to answer:       

• How did baby boomers’ balance sheets get where they are today (what roles did income growth, asset returns and savings rates play)?     
• Which assets—financial and/or nonfinancial—account for the dramatic growth in baby boomer wealth? We then tackle a more forward-looking set of issues: What will it take for subsequent generations—namely, gen-x and millennials—to reach retirement with a level of household wealth comparable to that of today’s baby boomers?   
• How will baby boomers spend their wealth as they transition from a high earning and saving period in their life cycle to a phase in which savings are drawn down to finance consumption? 
• Which assets (such as residential property, equity, bonds and managed assets) may come under selling pressure in this drawdown process? 
• How might baby boomers’ decisions in retirement impact the investment behavior of gen-xers in their peak earning and saving years? 

We find that even baby boomers’ financial exceptionalism does not ensure a retirement free of trade-offs. Financial assets (which accounted for only one-third of the growth in baby boomers’ total assets over the past 25 years) are likely insufficient for the median baby boomer household to support a desirable level of consumption in retirement; this will call for liquidating nonfinancial assets as well—the source of the other two-thirds of asset growth. The alternative—decreasing spending— would be less disruptive to the housing market but would reduce the tailwind behind aggregate economic growth arising from the strength of baby boomer consumption. Whether baby boomers aggressively spend down their assets in retirement, continue to save or make intergenerational transfers will ultimately determine the extent to which their financial exceptionalism translates into imbalances in welfare across generations. These are important considerations and trends to follow for younger and older generations alike, as well as for those helping them to invest wisely for positive retirement outcomes. 

It is difficult to overstate the demographic exceptionalism of the US baby boomer generation. The surge in post-World War II birth-rates — which increased by about a third compared with the 1930s’ lows and peaked two-thirds higher than today’s — gave rise to a long period of economic prosperity and stability. For instance, baby boomers began to enter the labor force in the 1960s and continued to do so through the 1980s. Over that period (1965-90), labor force participation increased from 59.2 per cent to 66.5 per cent, providing a steady tailwind to US economic growth. Combined with the anchoring of inflation expectations in the early 1980s, the new labor market equilibrium laid the groundwork for an extended period of relatively steady investment and productivity growth, contributing to an era known as the Great Moderation (generally defined as beginning in the mid-1980s and ending around 2008). 

Mind the gap! 

During this period of stable growth and moderate inflation, baby boomer balance sheets thrived. In stark contrast, today’s younger households, without having had the benefit of a similarly benign economic environment during their early-to-mid-prime earning years have not fared as well. In fact, those 35 to 44 years old today have a median net worth of approximately $47,000, compared with $102,000 for those of a similar age 25 years ago. As a result, the net worth distribution across age cohorts looks radically different today than it did a quarter of a century ago. 

Additionally, the shape of the wealth distribution has evolved away from the “inverted U” of the late 1980s to something more closely resembling an upward-sloping line in 2013. This implies that the savings behavior of older households has been changing over time. The inverted U pattern of wealth a generation ago as a characteristic feature of the life-cycle hypothesis, a theory seminally described by Franco Modigliani and Richard Brumberg in the 1950s. According to the life-cycle hypothesis, households accumulate wealth through their working years and then draw it down in retirement to finance consumption. 

Life-cycle savings, in turn, is related to Milton Friedman’s permanent income hypothesis, which states that people smooth out consumption over time by increasing spending in proportion to changes in their lifetime (“permanent”) income. While even in 1989 the wealth distribution by age group did not have a perfect U shape (after all, precautionary savings and bequest motives also influence the amount of savings in retirement), it is clearly the case that the life-cycle dynamic has weakened over the last quarter century. 

Viewed through the lens of these theories, the higher level of wealth among today’s older households vs those of preceding generations implies one of two things: 

• Windfall gains in asset valuations have increased wealth levels specifically for today’s older households. The gap in net worth between older and younger age groups has widened considerably, with the median for younger groups declining and older groups increasing higher level of permanent income—and hence more consumption spending power—into retirement than their parents’ generation did. 
• Savings rates for older households have been increasing over time. That is, older households are simply retaining more income than they used to. 

The implication of baby boomer wealth for asset prices and for the prospects of future generations will depend crucially on which story is correct. If older households’ permanent income is higher today but their savings behavior is the same as it has always been (that is, savings rates decline in retirement years), then baby boomers’ balance sheets will be drawn down rather aggressively to finance retirement consumption. Younger households will benefit indirectly from the faster economic growth that spending will confer. If, on the other hand, savings behavior for today’s older households has changed, baby boomers may well maintain relatively large balance sheets in retirement. In that case, the drawdown will be more gradual and diffuse, and the benefits to younger generations more direct as assets transfer intergenerationally. As we document, both stories are true to some extent: baby boomer asset growth came both from high, stable returns and relatively high savings rates. 

On the younger side of the age spectrum, household balance sheets are in decidedly worse shape than they were a generation ago. Both the 35-to-44 and the 45-to-54-year-old cohorts had lower net worth in 2013 than their comparable age groups did in 1989. In contrast to the 55-and-older cohorts, this phenomenon could reflect relatively poor asset performance for those age groups, lower income growth, lower savings rates or (as we will show) some combination of the three. In any event, the weaker performance of the younger house- holds’ balance sheets underscores the growing inequality in net worth across age cohorts. 

Inequality among gen-xers 

Another perspective on the wealth of younger households can be gleaned from the changing distribution of net worth over time within different age groups and the skewness of net worth — a measure of inequality — has historically been much higher for younger vs. older house-holds. Stated differently, the vast majority of younger house-holds have relatively low levels of net worth, but a few high net worth outliers skew the distribution to the right. 

In the 1980s and 1990s, wealth skewness for the older house-holds was positive but relatively low and stable. Then, in the 2000s, the distributions for middle-aged house-holds began to change and the level of implied inequality increased; by 2013, the skewness of 35-to-44-year-olds’ household net worth was just as high as it was 15 years earlier for those under 35 years of age. Evidently, the wealth inequality within the youngest age groups has persisted over time; moreover, wealth inequality has generally been increasing for most age groups except the oldest ones. 

Taken together, these two trends—the increasing gap in median household wealth between older and younger age groups and the growing wealth inequality within younger and middle-aged cohorts—imply that the number of households with increases in net worth over the past 25 years was much higher for today’s older age groups. 

Benjamin Mandel is Executive Director Global Strategy, Multi-Asset Solutions at JP Morgan while Livia Wu is Analyst, Quantitative Research Multi-Asset Solutions.