How Demographic Trends Could Affect Your Portfolio

Demographic changes in the United States and elsewhere have major implications for investment risks and returns. The combination of declining birth rates and increasing numbers of retirees could have disastrous consequences for retirement plans and wealth creation. Therefore, any portfolio should be constructed with the older population in mind.

In this article, we'll show you what demographic trend risks you should look out for and what effects they can have on your portfolio.

The Baby Boomer Time Bomb

Statistics provided by the U.S. Department of Health and Human Services, in conjunction with the Administration on Aging (AOA), illustrate the economic implications of a growing population of older adult Americans. By 2040, the number of people older than 65 is expected to increase to almost 21.6% of the country's population, up from about 16% in 2018.

Some experts believe that this increase in older adults will bring about a kind of "asset meltdown." This suggests that as the post-war baby boomers retire, they will convert their investments to cash in order to consume more. At the same time, the shrinking number of younger people—who tend to buy rather than save—will further reduce the demand for all kinds of investments.

If this ticking time bomb scenario materializes, it could lead to a disastrous decline in asset values, extending from equities to bonds to real estate. A downward spiral in the capital and investment markets might last for decades.

Declining Investment in Equities

The Survey of Consumer Finances indicates that population shifts can have a significant impact on investor behavior and equity values. We can see by the data published by the Federal Reserve at the end of the first quarter of 2021, the group that generally invests the most (older adults) owns a greater percentage of the stock market.

Investors 55 and older own 74.5% of corporate equities and mutual fund shares. The percentage of investment declines as the population gets older. Investors 70 and older own 28.8% of equities and funds. However, this decline is to be expected as people accumulate stock during their prime earning years and then convert their equities to cash or more conservative investments during retirement.

The theory is that investors who are closer to retirement will be less willing to tolerate investment risk as they will not have enough time to rebuild their investments should there be a downturn in the markets. As older investors sell off their equities, this would have a negative effect on capital markets and U.S. equity values. Still, there are other demographic factors that could preclude or dampen the impact of this potential decline, such as trends in immigration, business cycles, and emerging markets.

Trends to Watch

Despite the challenges posed by a population of older people, it is feasible that investment and consumer behavior may change for the better as a result of large influxes of immigrants. A country such as the United States already has substantial immigrant flows and will have less to fear than other countries with lower immigration rates. This trend may change, too, and the ultimate result depends partly on the extent to which influences from America or continental European countries spill over into the whole of North America.

Also, business cycle trends caused by different factors, such as entrepreneurship, investment, or technological developments, may prove more significant than population changes. If such trends do prevail, they may cause strong economic growth—known as the demographic dividend.

In any event, these demographic trends not only create risks but also opportunities. A clear implication is that investors may want to focus on emerging market economies and regions where demographic trends differ from those back home. 

Examine Demographics to Find Future Winners

The retirement of baby boomers will have a widespread impact on the American economy in other ways besides the effects we could see in the equity markets. An increase in demand for the products and services used by older adults could provide investors with new opportunities in certain sectors, such as healthcare and financial services.

While this does not automatically mean that buying stocks from the major drug companies or health sector funds are smart investments, as many are already yesterday's winners, it does provide us with some targets worthy of additional research. The winning companies of the future will be those that provide a variety of cost-effective services to older adults and retirees. These services extend to medical treatment, assisted living facilities, travel, and anything else focusing on that specific target market.

The large number of retirees who are relatively poor suggests that luxury services may not make the best investments. However, firms that produce medical and orthopedic products for older adults could do well if prices fall over time.

It is also important to consider the risks associated with biotechnology sectors. These sectors can be extremely volatile. Therefore, they are not for low-risk investors—ideally, for most investors, only a small portion of a portfolio should be allocated to these funds and equities.

Monitor Population Trends

It is difficult to project prevailing demographic trends and their impact on future asset values. However, it is less difficult to monitor trends as they evolve and to rebalance your portfolio accordingly over time. Such ongoing vigilance is essential in view of the major changes in the investment landscape that inevitably will result from the relationship between birth, death, and what happens in between.

While no investor can accurately predict what the coming decades will have in store for the financial markets, there are a few strategies to consider trying if you believe that the baby boomers' retirement could weigh on the marketplace.

For example, you should monitor population trends in any country in which you invest, particularly the developed regions like North America, Western Europe, or Asia. If the investing public continues to decline, consider reducing your investment in equities in general. Certain types of bonds and other asset classes like hedge funds might provide lucrative alternatives.

Also, consider investing more in equities and property in dynamic economies where populations are rising and remain younger. Parts of Asia and South America would be the prime targets in this case.

The Bottom Line

If you're concerned about this effect, you'll need to keep observing these trends so you can be prepared to act on them, if necessary. Demographics are always in flux, and so are the investment opportunities associated with them.