What a different picture the dynamic ratio paints! It suggests that demographic support for saving could well be as strong a decade from now as it has been in recent decades – and illustrates the extent to which traditional static ratios may be flawed.
We concede that our dynamic ratio forecast is only a guess as to what the future may look like if current trends persist. But there is some method to the madness. For example, the reason we start to phase the 65- to 69-year-olds into our Peak Saver group specifically in 2000 is that senior labor force participation began to rise rapidly in that year (after two stagnant decades). Our five-years-later-in-life-by-2050 employment assumption is slightly more arbitrary, but reasonable given that, globally, the largest increases in retirement age likely lie ahead of us. And our dynamic ratio does not account for the rising share of seniors 70+ who remain working, introducing an element of conservatism to our assumptions. So while our dynamic ratio embeds some simplifying assumptions, to be more scientific risks missing the forest for the trees. Almost regardless of the assumptions used, if you define a dependency ratio dynamically – based even loosely on observable trends – you are likely to paint a very different (and more accurate) picture of the future than you will paint using a static ratio.
What about the rest of the world? It appears we’ve made an argument about global demographics supported mainly with U.S. data. However, publicly available data for other economically significant regions does not permit as granular an analysis as we have shown for the U.S. We do have reason to believe similar trends are occurring outside the U.S.: Elderly labor force participation is rising in Europe, the UK and Japan, and some countries – including China – are contemplating raising the retirement age. In Japan, whose demographic cliff materialized many years ago, senior labor force participation has been trending higher, and as a result the labor force shrank only about 0.8% over the past decade even as the “working-age population” (aged 15 to 64) fell almost 9%. Patterns like this one are likely to repeat in other aging countries as societies adapt to meet their demographic challenges.
Bottom line: The people who move the needle most in saving demand, the highest earners, are the people working and saving later in life. This trend should be a tailwind for saving demand in the years to come that will push the global demographic cliff at least a decade into the future – and support a low global neutral interest rate, per the savings-investment equilibrium. 70 is the new 65!
U.S. household (demographic) demand for fixed income assets: a decade-long tailwind for bonds
We’ve just argued that demographics should help keep the global neutral rate low over the coming decade – which means that market yields in the U.S. should have a low “anchor.” But waves of baby boomers are retiring (albeit, as we have argued above, increasingly later), and many will eventually draw down (i.e., sell) their financial asset holdings to fund late-life consumption. Are we fast approaching the point when boomer drawdowns create selling pressure in fixed income markets that pushes interest rates higher? Or might U.S. aging (boomers included) actually bolster the (net) demand for bonds and help maintain a low ceiling for market yields?
Consider two key observations.
• First, as we should expect, investors generally de-risk away from equities and toward fixed income with age – most aggressively once they reach their 60s (and beyond).5
• Second, individual asset accumulation and drawdown patterns vary significantly by income level. In the U.S., individuals in the lowest income quintile tend to sell their limited financial assets beginning in their 50s and completely exhaust their assets by, or before, death (relying on social assistance to meet their basic needs in life’s latest stages). Middle-income individuals tend to draw down financial assets beginning in their 60s but not at a rate that would deplete their assets before death. Individuals in the highest income quintile, however, are shown to have rising financial asset balances until roughly age 80 (after which they decline only very gradually). In other words, for top-income-quintile individuals, portfolio drawdowns don’t tend to begin until roughly age 80 (an important point). The highest earners have historically been able to fund retirement consumption from income (generally employment income, investment portfolio income and annuitized income), “leaving their financial assets virtually untouched.”6 Here’s the key: Top-income-quintile households own over 80% of U.S. household financial assets. Consider how significantly this group’s future asset accumulation and drawdown profile will impact financial markets!
Back to our question about whether U.S. demographics will be a headwind or tailwind for bond flows in the years ahead. For starters, we assess when (demographics-driven) bond buying might peak relative to bond selling. We define “Bond Buyers” as individuals aged 60–74 and “Bond Sellers” as individuals 80 and older. These age definitions are somewhat arbitrary, but they’re based on the two previously introduced empirical observations about households in the top quintile of the U.S. income distribution (which hold over 80% of U.S. household financial assets):
• Bond buying tends to peak during individuals’ 60s and early 70s (aggressive de-risking);
• Bond selling tends to peak in the years after age 80 (as individuals sell down their financial assets to fund consumption in retirement).