Why Boomers Won’t Crash The Stock Market
It seems to be one of the biggest fears about the stock market recently. Even going back a couple of decades, people have been warning about the oncoming disaster. This fear is simply that as baby boomers age and retire, they will withdraw money from the stock market and cause it to crash. Some people cite this as a good reason to stay away from traditional stock market investing for a generation or two.
Defenders of the stock market are quick to point out that other investors may step in to take their place, for example people in emerging markets buying more stocks. That line of argument is claiming that nothing will really change, which is certainly false. My argument is different: things may change but we don’t need to fear that.
It’s Simple: Supply and Demand
I wrote about this earlier when I noticed that retirees and near-retirees currently seem to be doing the exact opposite of the predictions and piling into the stock market in search of yield, against all logic. But even looking beyond current behavior there are deeper reasons not to panic over this. It’s all about supply and demand. The common fear is based on the argument that stock prices are based on supply and demand (true in the short term) and falling demand will reduce stock prices (often true).
If you look at it from a different angle the picture changes. Any investment market, whether it’s in stocks or bonds, will generate a certain total return for investors. This return is then distributed among all the capital currently in the market. So if there is more capital in the market each dollar will earn less returns, and if there is less capital each dollar will earn more returns.
In this case the returns are the supply and the capital is the demand. Falling demand means greater returns for those remaining in the market. This is great news, and given a little time it will more than make up for any initial drops in stock prices. Sure you would do a little better if you skipped that initial price drop, but in trying to do that you run the risk of missing out on much bigger gains.
The Market Adapts
Even that isn’t the end of the story. All along we’ve been assuming the supply is mostly fixed. That means prices would rise with increasing demand and fall with decreasing demand. That assumption is false. The supply isn’t fixed because the stock market is only one part of the overall economy. Other parts of the economy are filled by private companies, governments, and non-economic activity. To see a simple and direct interaction let’s just focus on one part of that: private companies. I’m sometimes saddened by the thought of all these profitable companies that I can’t invest in unless I’m friends with a few billionaires.
That dividing line can and does move though. If stock prices are generally low then wealthy investors will buy up public companies and take them private. This reduces stock market supply, and if demand remains fixed the prices in the stock market will rise. On the other hand if prices in the stock market rise to a high level like in the 90s, then both existing and new private companies will go public to get their piece of that capital which is free money to them. This increases supply. If demand is fixed, stock prices will fall.
Don’t Fear the Market
If you look at these forces the future looks much more promising. There is good reason to believe there is a certain floor on stock prices since large investors can take companies out of the market. And if prices do fall, long-term investors will be compensated by earning a greater portion of the future returns. The companies listed in the major stock markets around the world are powerful sources of profits and economic growth and I’m not about to miss out on that as long as I can buy them at a reasonable price.
It’s easy to point out that stock market prices have generally followed the investment lifecycle of baby boomers. Investors need to remember that we will not re-live those years and we can’t be sure of what caused what. Investment markets are an extremely complex system and anyone who thinks they can predict them precisely based on one factor alone or even a combination of factors that have been relevant in the past is deluded.