- March 4, 2012, 5:06 p.m. ET
INTERVIEW
By KAREN DAMATO
If you're a baby boomer, you've got a big problem when it comes to the investment returns you can expect in retirement: It's the sheer number of other boomers who are also getting ready to leave the workplace and rely on their portfolios to help pay the bills.
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Read a paper on Demographic Changes, Financial Markets, and the Economy by Robert D. Arnott and Denis B. Chaves.
That's the depressing conclusion Robert D. Arnott, a portfolio manager, asset-management executive and inveterate researcher, has come to in more than 20 years of studying demographic trends and financial-market results.
The problem in a nutshell: The ratio of retirees to active workers in the U.S. will balloon. As retirees sell stocks and then bonds to support themselves, there will be fewer younger investors to buy those securities, keeping a lid on prices. Meanwhile, strong demand from boomers and a limited supply of workers will boost the prices of goods and services the boomers need.
Mr. Arnott is the founder and chairman of Research Affiliates LLC in Newport Beach, Calif. He is well known in the fund world as the portfolio manager hired by Pacific Investment Management Co. to run Pimco All Asset and Pimco All Asset All Authority —as well as for creating fundamental indexes that weight components by measures such as corporate earnings rather than stock-market value.
The problem in a nutshell: The ratio of retirees to active workers in the U.S. will balloon. As retirees sell stocks and then bonds to support themselves, there will be fewer younger investors to buy those securities, keeping a lid on prices. Meanwhile, strong demand from boomers and a limited supply of workers will boost the prices of goods and services the boomers need.
Mr. Arnott is the founder and chairman of Research Affiliates LLC in Newport Beach, Calif. He is well known in the fund world as the portfolio manager hired by Pacific Investment Management Co. to run Pimco All Asset and Pimco All Asset All Authority —as well as for creating fundamental indexes that weight components by measures such as corporate earnings rather than stock-market value.
Robert Arnott is the outside manager of two Pimco mutual funds
At age 57, Mr. Arnott's interest in boomers is personal, as well as professional. Here are edited excerpts from a recent discussion:
WSJ: When you talk about a changing relationship between the numbers of retirees and workers in the U.S., how dramatic a shift from past decades are we looking at?
Mr. Arnott: This very year, for the first time in U.S. history, the population of senior citizens rises faster than the working-age population. Less than 10 years ago, when the baby boomers' kids were coming into the labor force and the very skimpy roster of Depression babies was retiring, we had 10 new additions to the working-age cadre for each one new senior citizen.
It goes to 10-to-1 in the opposite direction in 10 years. There will be 10 new senior citizens for each new working-age citizen. If that's not a political, economic and capital-markets game changer, I don't know what is.
WSJ: How does this changing mix of retirees and workers affect the investment returns that boomers can look forward to over the coming decades?
Mr. Arnott: Rates of returns are likely to be anemic and are likely to become more so for those who save later. I'm smack in the middle of the boomers. I was born in 1954. And by the time I reach 65 years old, the prospective forward-looking returns will have to be pretty skinny. That's by the end of this decade.
For U.S. stocks, the history of the last 100 years shows real [that is, inflation-adjusted] earnings and dividend growth of about 1.25% a year. Add that to the current dividend yield and you've got about 3.5% of real return. Add in inflation of, say, 2% or 2.5%, and you're looking at 5.5% or 6% [before inflation] a year.
Now with the interconnected influence of demography, debt and deficits, we're likely to see considerably slower economic growth than in past years. So I view stocks as having a forward-looking return of 5%, give or take, over the next 10 to 20 years.
If bonds are priced to give us, let's say, 2% to 4%, that means your balanced portfolio is likely to deliver 4%. Net of inflation and net of taxes, that's awfully close to zero real after-tax return.
WSJ: Is this payback for an earlier period when a bulge of working-age Americans helped push up investment returns?
Mr. Arnott: I never use the word payback. But the Japan stock bubble crested at the end of 1989; our bubble crested almost exactly 10 years later. Their demography is 10 years ahead of ours and worse than ours. The surge in mature workers, people in the 40-to-60-year range, is the sweet spot demographically for stock and bond returns. The surge in that population [in the U.S.] in the '80s and '90s helped to fuel the U.S. stock-market boom in the '80s and '90s, just as it helped to fuel Japan's boom 10 years earlier.
WSJ: Your prognosis for U.S. investors sounds in some ways too simple. And definitely too scary. In retirement, can't I sell my securities to workers in other countries? And won't other countries supply goods and services to boomers, taking some pressure off prices?
Mr. Arnott: Absolutely. But it is dangerous to overrely on that. What I'm painting isn't a doom-and-gloom scenario. What I'm painting is a scenario that is challenging, that's difficult. Compared with the '80s and '90s, it is awful. But the '80s and '90s were an extraordinary period.
You still have a lot of people expecting 8% or 10% a year from stocks or even from balanced portfolios. That's naive.
WSJ: In a new paper, you look at trends world-wide and you find more promising demographics in places such as Brazil, Russia, India and China. As a U.S. investor, can I get around this problem of anemic returns by investing heavily in those emerging markets?
Mr. Arnott: I think that's a crucial missing part of most investors' tool kits. Most investors think, "Emerging economies, my goodness, that's risky." Well they are cheaper than U.S. stocks, and the economies are ostensibly going to be the growth engine for the world economy in the coming 10 to 20 years. So doesn't that make them potentially less risky in terms of downside risk for the long-term investor?
And on the bond side, it is even more compelling. [While emerging nations have far less debt relative to the size of their economies than do the biggest developed nations], they pay 3% to 4% higher yields. It seems to me highly likely that that yield spread will collapse in the coming decade, giving you nice capital gains on top of fairly rich starting yields.
WSJ: How is your demographic research reflected in your stock exposure in the funds you manage?
Mr. Arnott: In Pimco All Asset and All Asset All Authority, we invest in stocks [in the U.S. and other developed markets] purely as a tactical asset. We don't view it as a core vehicle.
Today, U.S. stocks aren't cheap. The Shiller P/E ratio—price relative to 10-year smoothed earnings—is north of 20 times earnings. That's on the rich side. So in the two Pimco funds, as of Jan. 31, we had essentially nothing in U.S. stocks.
We had 35% of All Asset All Authority and 27% of All Asset in emerging markets, split roughly 70% bonds and 30% stocks. These economies offer higher yields and better debt coverage, paired with much richer growth opportunities than the U.S.
WSJ: How about a final encouraging word for beleaguered baby boomers?
Mr. Arnott: It's really simple: Save more aggressively; invest in economies that aren't afflicted by the 3-D hurricane of deficit, debt and demography; and diversify into markets that can serve us well in a reflationary world.
WSJ: And we need to work until we are 80?
Mr. Arnott: No. I think most boomers, if they invest sensibly, can retire roughly when they originally planned to or a year or two later. If they invest conventionally, it is three or four years later. And If they don't invest at all and rely on entitlements to take care of them in their old age, then yes, they work until they're 80.
Ms. Damato is a news editor for The Wall Street Journal in South Brunswick, N.J. Email her at karen.damato@wsj.com.
WSJ: When you talk about a changing relationship between the numbers of retirees and workers in the U.S., how dramatic a shift from past decades are we looking at?
Mr. Arnott: This very year, for the first time in U.S. history, the population of senior citizens rises faster than the working-age population. Less than 10 years ago, when the baby boomers' kids were coming into the labor force and the very skimpy roster of Depression babies was retiring, we had 10 new additions to the working-age cadre for each one new senior citizen.
It goes to 10-to-1 in the opposite direction in 10 years. There will be 10 new senior citizens for each new working-age citizen. If that's not a political, economic and capital-markets game changer, I don't know what is.
WSJ: How does this changing mix of retirees and workers affect the investment returns that boomers can look forward to over the coming decades?
Mr. Arnott: Rates of returns are likely to be anemic and are likely to become more so for those who save later. I'm smack in the middle of the boomers. I was born in 1954. And by the time I reach 65 years old, the prospective forward-looking returns will have to be pretty skinny. That's by the end of this decade.
For U.S. stocks, the history of the last 100 years shows real [that is, inflation-adjusted] earnings and dividend growth of about 1.25% a year. Add that to the current dividend yield and you've got about 3.5% of real return. Add in inflation of, say, 2% or 2.5%, and you're looking at 5.5% or 6% [before inflation] a year.
Now with the interconnected influence of demography, debt and deficits, we're likely to see considerably slower economic growth than in past years. So I view stocks as having a forward-looking return of 5%, give or take, over the next 10 to 20 years.
If bonds are priced to give us, let's say, 2% to 4%, that means your balanced portfolio is likely to deliver 4%. Net of inflation and net of taxes, that's awfully close to zero real after-tax return.
WSJ: Is this payback for an earlier period when a bulge of working-age Americans helped push up investment returns?
Mr. Arnott: I never use the word payback. But the Japan stock bubble crested at the end of 1989; our bubble crested almost exactly 10 years later. Their demography is 10 years ahead of ours and worse than ours. The surge in mature workers, people in the 40-to-60-year range, is the sweet spot demographically for stock and bond returns. The surge in that population [in the U.S.] in the '80s and '90s helped to fuel the U.S. stock-market boom in the '80s and '90s, just as it helped to fuel Japan's boom 10 years earlier.
WSJ: Your prognosis for U.S. investors sounds in some ways too simple. And definitely too scary. In retirement, can't I sell my securities to workers in other countries? And won't other countries supply goods and services to boomers, taking some pressure off prices?
Mr. Arnott: Absolutely. But it is dangerous to overrely on that. What I'm painting isn't a doom-and-gloom scenario. What I'm painting is a scenario that is challenging, that's difficult. Compared with the '80s and '90s, it is awful. But the '80s and '90s were an extraordinary period.
You still have a lot of people expecting 8% or 10% a year from stocks or even from balanced portfolios. That's naive.
WSJ: In a new paper, you look at trends world-wide and you find more promising demographics in places such as Brazil, Russia, India and China. As a U.S. investor, can I get around this problem of anemic returns by investing heavily in those emerging markets?
Mr. Arnott: I think that's a crucial missing part of most investors' tool kits. Most investors think, "Emerging economies, my goodness, that's risky." Well they are cheaper than U.S. stocks, and the economies are ostensibly going to be the growth engine for the world economy in the coming 10 to 20 years. So doesn't that make them potentially less risky in terms of downside risk for the long-term investor?
And on the bond side, it is even more compelling. [While emerging nations have far less debt relative to the size of their economies than do the biggest developed nations], they pay 3% to 4% higher yields. It seems to me highly likely that that yield spread will collapse in the coming decade, giving you nice capital gains on top of fairly rich starting yields.
WSJ: How is your demographic research reflected in your stock exposure in the funds you manage?
Mr. Arnott: In Pimco All Asset and All Asset All Authority, we invest in stocks [in the U.S. and other developed markets] purely as a tactical asset. We don't view it as a core vehicle.
Today, U.S. stocks aren't cheap. The Shiller P/E ratio—price relative to 10-year smoothed earnings—is north of 20 times earnings. That's on the rich side. So in the two Pimco funds, as of Jan. 31, we had essentially nothing in U.S. stocks.
We had 35% of All Asset All Authority and 27% of All Asset in emerging markets, split roughly 70% bonds and 30% stocks. These economies offer higher yields and better debt coverage, paired with much richer growth opportunities than the U.S.
WSJ: How about a final encouraging word for beleaguered baby boomers?
Mr. Arnott: It's really simple: Save more aggressively; invest in economies that aren't afflicted by the 3-D hurricane of deficit, debt and demography; and diversify into markets that can serve us well in a reflationary world.
WSJ: And we need to work until we are 80?
Mr. Arnott: No. I think most boomers, if they invest sensibly, can retire roughly when they originally planned to or a year or two later. If they invest conventionally, it is three or four years later. And If they don't invest at all and rely on entitlements to take care of them in their old age, then yes, they work until they're 80.
Ms. Damato is a news editor for The Wall Street Journal in South Brunswick, N.J. Email her at karen.damato@wsj.com.
A version of this article appeared Mar. 5, 2012, on page R6 in some U.S. editions of The Wall Street Journal, with the headline: Bad News for Boomers.
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Demographic trends will depress portfolio returns, this researcher warns
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