The inflows from Social Security payroll taxes have been surpassed by outflows for several years as more people retire. Aside from the obvious elephant in the room (i.e., the fact that if something doesn’t change, the program will run out of money by 2033), the more people retire, the less money will be allocated to retirement-focused investment accounts and pension funds as well.
Additionally, with an ever-smaller labor force expected to take care of an ever-larger elderly population, an economic contraction could be in the cards, as the workforce will decrease and some may not be able to work as much due to taking care of retired family members.
According to the Social Security Administration’s website, “The long-range 75-year actuarial deficit of the combined OASI and DI trust funds increased from 3.21 to 3.54 percent of taxable payroll since the 2020 reports.” This shows enough of an impact from the Covid-19 pandemic to cause the programs to run out of funds a year earlier than expected. By the time 2034 rolls around, if nothing changes to support Social Security, approximately 76% of benefits will be payable.
The U.S. stock market has been charging ahead on a strong bull run since shortly after the beginning of the Covid-19 pandemic, and prices don’t seem like they will come down soon as easy monetary policies combine with an improving economy and increased retail trading volume. However, the Fed has often cited the deflationary pressures of the ageing population as justification for allowing interest rates to run higher over the past year. Considering this, could the bull market begin to lose steam in the coming years?
How much do retired people draw on their investments?
It would make sense to assume that most retired people will begin to draw on their pension funds, 401k’s and other investment funds after they are no longer generating income through work. In addition, once they are no longer working, people are no longer setting aside a portion of their paychecks for retirement funds, which will further decrease the demand for stocks.
However, the amount of stock sold in retirement depends on the person. While retired people may begin to draw on their investment accounts to pay their bills after retirement, and it’s practically a given that most 401k’s will be withdrawn, some might buy more stocks instead if they are wealthy enough.
As James Poterba noted in his paper “The Impact of Population Aging on Financial Markets,” which was published with the National Bureau of Economic Research, wealthier people are more likely to survive to old age. As wealthy people get older, they are likely to continue accumulating stocks and other assets with the passive income generated from their investments.
The overall result of the country’s wealthier people continuing to accumulate assets in old age is that, on average, there appears to be no statistically significant correlation between age and accumulation of assets, which should mitigate the effects of the ageing population in the short term.
However, if Social Security benefits are allowed to decrease, which they will unless Congress intervenes to fix the problem, this situation could change. An over 24% reduction in Social Security payments would mean that retirees would need to rely more on their stock-based retirement accounts for funds.
A long-anticipated problem
While the ageing population is certain to exert a downward push on asset prices, it’s not like this problem is coming out of nowhere. It’s also not going to be the only factor that affects the economy or asset prices.
Typically, it’s not the expected events that people are prepared for that cause the stock market to crash. Instead, it’s the unexpected ones which make people rush for the exits in a panic.
History has shown time and time again that stock prices don’t necessarily reflect the underlying economy. In fact, the opposite is often true, with the most recent example being that the Covid-19 pandemic and subsequent economic recession gave birth to a bull market. Covid-19 caused the stock market to crash, but the snail-pace problem of the ageing population isn’t likely to cause panic.
Moreover, a long-term issue means a long timeline for people to develop a solution. Institutional investors, who are responsible for managing approximately 90% of investments, have long been preparing for this particular issue and taking steps to ensure that their profits do not drop due to demographics.
Some investing strategies to counteract demographic trends include increasing allocations to assets that will benefit from the ageing population, such as health care, as well as assets that will not be materially affected by the retirement of older generations, such as tech stocks and other companies that have yet to reach their full potential.
A global economy
One factor that many U.S. fund managers are counting on to counteract demographic trends in their home country is the increasingly globalization of the world’s economies. The more a country’s economy participates in the global economy, the more it will be affected by worldwide demographic trends and the less it will be affected by local demographic trends.
The reason for this is twofold. For one, companies can expand to other countries once they have established a foothold of success in their home countries, thus increasing their income beyond what their home countries are able to support. Additionally, it is easier for investors to invest in foreign equities and assets where they see the greatest opportunity.
Fixing social security
While no federal-level action has yet been taken to augment the Social Security program, something will need to be done soon, otherwise the program will become un-fixable. A deficit over 3% that will only increase over time is a problem that will increase in severity as time goes on.
One solution proposed in Congress in 2019 was Secure2100. This plan would expand social security benefits by gradually increasing payroll taxes for the program from 12.4% to 14.8% and applying the Social Security payroll tax to annual earnings over $400,000 (currently, the IRS does not attempt to collect taxes on annual income over $132,900, claiming the task is “too hard”).
Some have also tossed around the prospect of investing Social Security and Disability Insurance funds in the stock market, as stocks have a higher return potential than bonds. However, stocks also carry a much higher risk of loss compared to bonds. Having Social Security invested in stocks would also give the government more of an incentive to keep stock prices high regardless of the costs, which could result in drastic fiscal stimulus measures such as negative interest rates or government acquisition of important companies facing imminent bankruptcy (much like how the major U.S. airlines had to issue stock warrants to the government in order to be bailed out in 2020).
The Social Security program has recently been in the news again with the announcement that it will run out of funding a year earlier than expected due to Covid-19 and an estimated permanent decline of 1% in GDP. Congress also has yet to decide on a proposal to solve this issue, and the longer a solution is put off, the greater the impact of the deficit will become.
However, this has already been factored into the strategies of many institutional fund managers. There are also many factors aside from demographics that will affect the economy and stock prices going forward. While there will likely be some downward pressure on stock prices due to the ageing population, this could be outweighed by other factors such as economic globalization, immigration, people retiring later (if health care improves) and so on. The future is not set in stone, and a long-anticipated problem like this one isn’t likely to causes investors to panic-sell.