Will this Nice Couple Bring Down The Market?
Some forecasters predict that the baby boomers' impending retirement will ruin your financial future. Here's why they're wrong--and how you can actually profit from the graying of America.
By Michael Sivy

(MONEY Magazine) – No matter when you were born, you march to the beat of the baby boom. The high birth rate after World War II created a generation of 76 million whose sheer size has shaped U.S. consumption and investment trends ever since. When the number of children ages five to 14 increased more than 40% between 1950 and 1960, sales of potato chips rose even more. When the boomers entered their peak saving and earning years in the mid-1980s, the stock market began a powerful advance that lasted 15 years.

But the boomers are also busters. When they move on, what they once embraced tends to languish. That was true for the Hula Hoop, for the huge number of primary schools built in the 1960s and for the Peace Corps. Now that the boomers are about to make their biggest move yet--leaving the work force and heading for retirement--forecasters are wondering whether the economy, the financial markets and home values will languish too. And some of those peering into our collectively graying future are terrified by what they see.

An economy that can't grow To sustain a healthy growth rate, an economy needs more workers who get more done. But the share of the U.S. adult population in their prime working years is about to start dropping, from 80% today to 70% by 2035. Growth of the labor force will all but disappear after 2013, according to projections by the Social Security Administration. And as the most experienced people quit, productivity gains that are running 2% or more a year could fall to 1.3%. The result: Annual growth in inflation-adjusted gross domestic product would decline by more than a third, from around 3% to 1.9%, and remain that low for decades. That paltry growth rate will be accompanied by the return of inflation, as an aging population puts increasing demands on the government, driving up deficits and interest rates.

Falling stock market returns If the economy can't grow and inflation is back, stock prices will suffer. On top of that, demand for equities will plummet as boomers cash out. By 2035 there will be 40 million additional Americans over age 65 who are in the process of liquidating six-figure portfolios. At least $4 trillion will come out of the stock and bond markets. The result isn't necessarily a nasty bear market as in 2000 or 1973-74, but something more insidious in which stocks don't get any wind at their back for a long, long time.

Collapsing real estate values And what will happen to housing prices when 76 million people decide to cash out and move someplace warm? A 2002 study by Dean Baker published by the liberal Center for Economic and Policy Research warns that as the boomers divest their real estate, they will help drive "the collapse of the housing bubble, implying a drop of between 11% and 22% in the average of housing prices, [that] will destroy between $1.3 trillion and $2.6 trillion in housing wealth."

Wrap it all up and you have the 1970s, less the Eagles. But this slump would last for decades, and in a single generation the Land of Opportunity would become the Land of Stagnation. Yes, this vision is scary, and even plausible--but fortunately, it's not likely to come true. The retirement of the boomers will likely prove a mild negative for markets, and it certainly will set off big changes in the economy. But those changes will also create particular opportunities for you as an investor.

First, let's dispense with the doom and gloom view. It rests on two shaky assumptions that trip up forecasters all the time. The first is that if you change one element in a complex system, everything else can remain the same. The second is that any one factor alone drives such a system.

Take the housing market. Studies predicting the apocalypse are nothing new. The best-publicized one was done 16 years ago by N. Gregory Mankiw and David N. Weil, and it projected that housing prices would fall as much as 47% over the ensuing two decades. The reason: aging baby boomers. It's naive, of course, to think that the boomer retirement won't cause some shifts in the real estate market. But before you sell your well-appreciated suburban house in a panic tomorrow, consider what's happened in California over the past 10 years. Between 1995 and 2000, more than 2.2 million people left the state. Many were middle class or affluent and sought to cash out of their pricey homes and resettle in the sunbelt. If you look at that statistic in isolation, you conclude that home prices must have crashed. In fact, California prices started rising in 1997 and haven't stopped. Why? More than 1.4 million new residents arrived, interest rates fell, and the economy improved.

Indeed, the discussion always returns to the economy. The number of Americans 65 and older will more than double by 2035, and as a percentage of the population over age 25, they'll increase from 19% to 30%. A bit of the dynamism of the U.S. economy will be lost as so many people slow their production and their consumption. But the doomsayers overstate the case.

The boomers may start "retiring" in 2008, but that doesn't mean they're all going to leave the labor force. The average boomer didn't start saving for retirement until age 32. The generation that followed typically began seven years earlier, according to a 2004 survey by Transamerica. The older boomers had to suffer through the stagflation of the 1970s. It's only those born after 1957 who enjoyed a steadily improving economy after they left school. As a result, many of the people who reach retirement age between 2008 and 2019 won't have the money to stop working altogether. And others won't want to. The "gold watch and golf" image of retirement is outdated. Men and women who retire from their career jobs frequently go to work somewhere else. In fact, more than a third of those who receive income from private pension plans are employed. That suggests the economy won't grind to a halt.

What about the fear that boomers will rapidly liquidate their savings? After all, even if economic growth remains solid, a massive outflow of funds could depress stock returns. But the boomers aren't going to yank their money out all at once, if ever. The richest 20% of them have seven times as much money as the median and will inherit the better part of $1 trillion in the next 10 years. Some affluent boomers will sell stocks and bonds, but most of the generation's savings are held by people who won't need to liquidate. And any selling will be absorbed by higher savings rates among younger workers. Generation X is smaller, of course, but they're contributing money to tax-deferred accounts much faster than their elders did. While 401(k) participation among younger workers declined during the last bear market, it's still an impressive 59%. In addition, a far greater percentage of today's workers have the chance to contribute to 401(k)s than people did 25 years ago, and the ceilings for contributions are much higher.

In the end, the boomers won't destroy their own and everyone else's financial future. But their aging means you should look anew at your investing strategy. This is an opportune time to plan ahead. Stocks today are more attractive than they've been for a decade. In fact, large, top-quality growth stocks look undervalued, trading at an average P/E of 21 vs. a historical average of nearly 25 and peaks above 50. There's ample opportunity to find long-term bargains if you can identify industries likely to enjoy superior growth over the next 10 or 20 years. We've identified three strategies that take advantage of broad trends just beginning to emerge in the U.S. economy--and that should keep it from languishing in the years ahead.


track the big spenders

Baby boomers account for more than half of U.S. spending, and the older they get, the deeper their pockets. Those over age 50, who make up only 12% of the total population, will account for more than a fifth of total U.S. spending in 2005. As more boomers approach retirement, forecasters expect a huge bump up in certain kinds of expenditures. Two that should see the biggest jump are travel and health care. In 2003, travelers ages 55 to 64 ponied up $15 billion for vacations, spending 40% more on average than other age groups. People 50 and older account for more than half of all health-care spending. And another boomer reaches the big five-oh every seven seconds. --TARA KALWARSKI

There Will Be More Older People...

Millions of Americans 65 and over

NOTE: Projected as of July 2004. SOURCE: U.S. Census Bureau.

HEALTH CARE National health-care spending, which hit nearly $1.8 trillion in 2004, will increase as a percentage of GDP by 22% over the next 10 years. For that the health-care industry can thank the boomers, who are just beginning to enter the time of their lives when drug, hospital and other expenditures rise dramatically (see the chart at right). Picking winning companies here isn't as easy as it might appear. With power in numbers, the boomers could put pressure on prices, making new medical developments less profitable for some companies. So consider capturing the broad opportunity with the Vanguard Health Care fund (VGHCX), which invests in all areas of the industry and has a 0.28% expense ratio. Manager Ed Owens has racked up a 19% annualized return over 15 years, putting the fund at the top of its category. If its $25,000 minimum is too steep, try T. Rowe Price Health Science fund (PRHSX) with a more reasonable $2,500 minimum (but higher 1% expense ratio). Manager Kris Jenner is a physician by training, and over the past five years his fund's average 7.4% return beat 71% of its peers.

If you invest in individual stocks, consider Amgen (AMGN), one of Jenner's top holdings. Amgen has a dominant position in the cancer marketplace thanks to two drugs that alleviate side effects caused by other therapies, including chemotherapy. Cancer treatment, unfortunately, looks to be a high-growth industry as the boomers age. People over 55 represent 76% of all diagnoses. Over 1 million new cases are expected in 2005, and cancer has surpassed heart disease as the leading killer of Americans under 85. Amgen shares aren't cheap: They trade at 22 times estimated 2005 earnings, compared with the average health-care stock's 18. But that's still cheaper than the the other mature biotech giant, Genentech, which trades at 43 times earnings. And Amgen has posted average earnings growth of 20% over the past 10 years; analysts expect more of the same.

...Who Spend the Most on Health Care

Health-care spending by age

SOURCE: 2003 Consumer Expenditure Survey.

TRAVEL "As people get older, they lose interest in mountain climbing or skiing," says Mark Greenberg, the manager of the AIM Leisure fund. So where will aging boomers head for fun? Vegas, baby! Casino and other gaming companies, which make up 15% of the fund's holdings, have been on a winning streak, and Greenberg expects that to continue. After all, older tourists, which Vegas keeps getting more of, stay longer and spend more. In 2003, three-quarters of the city's visitors were over 40; and they budgeted a third more cash than younger visitors to play the tables and slots. Greenberg likes Harrah's Entertainment (HET) as the best way to bet on Las Vegas and the gambling industry. The company runs 28 casinos in Vegas, Atlantic City and other parts of the country and will soon add Caesars Entertainment to its portfolio. "They know their customers better than any casino company in the world, and they know the boomers are coming," says Greenberg. At $69, shares trade at a P/E of 19. Earnings growth is expected to average 15% over the next five years. Greenberg's fund owns $60 million worth of Harrah's shares. He started buying in 1998 at $15 a share and believes that the stock could hit $125 in the next five years.


work the brain drain

You know that boss you've been hoping would retire? He soon will, along with tens of millions of other senior employees across the country. Baby boomers, expecting longer, healthier lives, say they are going to retire later than their parents. And they very well may. But retirement research firm EBRI says most people call it quits earlier than they plan. Executives get sick, are pushed out or decide that golf and better weather are appealing after all. According to the Bureau of Labor Statistics, 35 million boomers will retire between 2000 and 2020. Another 23 million will pack up their offices in the following decade. Sure, immigration will fill some of the gaps. But corporate America will have to continually find ways to boost productivity and learn how to do more with fewer of its most experienced workers. That means an opportunity for two sectors that help companies get more from less, technology and consulting. --STEPHEN GANDEL

SOFTWARE Research firm IDC predicts that technology spending, which stalled in the past half-decade, will jump 6% annually for the next four years. Many of those dollars will be spent on software, which can offer the biggest boost to productivity. The easiest way to invest in the trend is the iShares Goldman Sachs Software Index Fund (IGV). The exchange-traded fund's 47 holdings span from giant Microsoft to tiny Ariba, which makes software that analyzes corporate spending patterns. A good long-term, though riskier, software play is the fund's second-largest holding, Oracle (ORCL). It is the world's largest maker of databases, the digital file cabinets that are fundamental to any technology system requiring computers to store and retrieve information. Oracle's next generation of software will allow databases to handle day-to-day tasks like approving expense accounts and negotiating prices. "People will be needed only on an exceptional basis," says Robert Shimp, Oracle's vice president of technology marketing. Oracle is also growing through acquisitions, and that's a risk. Late last year, Oracle bought PeopleSoft, one of the largest makers of business applications that make use of databases. Large acquisitions rarely go off smoothly. For that reason, Oracle's shares, at a recent $13, have a lower price/earnings ratio than those of rival SAP--21 vs. 27, based on 2005 earnings. That could mean more upside for long-term shareholders. "As businesses look to grow and increase productivity, technology companies, and specifically Oracle, will benefit," says Jason Maxwell, a portfolio manager at TCW Group, which owns 13 million Oracle shares.

CONSULTANTS Most executives can handle decisions about budgets, marketing and production. But the massive changes that will result as the boomers retire are far from ordinary. Cue the consultants. Accenture (ACN), the largest publicly traded U.S. consulting firm, helps managers with everything from staffing to software needs. In the past few years, much of the growth in consulting has been in moving jobs overseas. That's hurt Accenture, which has lost clients to less expensive foreign rivals. But Walter McCormick, a senior portfolio manager at Evergreen Investments, says companies will return to Accenture when it comes to issues beyond cutting their labor costs.

What's more, Accenture's Indian competitors have to deal with wage increases at home. "The gap is closing pretty quickly between what it costs to hire Indian consultants vs. Accenture," says McCormick, whose company holds 2.2 million shares of Accenture in its funds. The company's stock, recently trading at $25, is worth $30, McCormick maintains.


follow the wealth

When Jimi Hendrix sang, "You better save it, babe. Save it for your rainy day," from his hit "Fire," he probably wasn't trying to dispense lasting financial advice to the throngs at Woodstock. They waited awhile to start socking away money, but his audience eventually took the lyrics to heart. By 2020, when the last of the boomers turn 55, they will own $20 trillion in assets, or $461,000 per household on average, according to Boston College's Center on Wealth and Philanthropy. Will it be enough? With Social Security in trouble, companies cutting back pension plans, and life expectancies growing, it's hard to say. But what is certain is that as boomers move from the work force to the golf course, they will want to make their savings last. That means a repositioning of assets--swapping houses and redoing financial plans--that will cause swings in the real estate market and an opportunity for companies offering advice and financial products. --S. G.

REAL ESTATE Even before they retire, boomers have begun to alter the housing market's dynamics. "We have seen a lot of pre-positioning. Boomers are buying that retirement home before they have sold their current residence," says Douglas Duncan, chief economist at the Mortgage Bankers Association. Rising demand for second homes has boosted the housing market and kept home builders and their stocks performing well. But when boomers start to cash out of their suburban homes, developers that concentrate on building McMansions in commuting areas of the Northeast and the West Coast may falter. A recent study by the National Association of Realtors found that buyers over age 55 are more than twice as likely to buy an apartment than they were at an earlier age, and that they want to live in the South. Those trends bode well for WCI Communities (WCI). WCI generates 91% of its revenue in Florida, mostly from building luxury apartment buildings in coastal areas. With 17,000 acres of undeveloped land, WCI Communities has room to expand. Today single-family homes are what's hot, so WCI shares aren't catching fire. At $34, the stock trades for 10 times estimated 2005 earnings, a bit less than the average builder.

Of course, it might be a decade before boomers depart en masse to the sunny South. Until then, AvalonBay Communities (AVB), a real estate investment trust that rents luxury apartments and houses in Boston, New York City and Washington, should see growth. Boomers are trading in their family homes for the conveniences of city life. A quarter of AvalonBay's residents are boomers, up from 10% a decade ago. With a dividend of 4%, the company's shares, at a recent $72, are a good option for investors looking for income. "The apartment market is poised to do well," says veteran REIT investor Martin Cohen. AvalonBay is among the largest holdings in his Cohen & Steers Realty Shares fund.

FINANCIAL SERVICES The value of assets being withdrawn from retirement savings plans each year will more than double to $400 billion in the next decade. That's good news for financial planners. The majority of retirees seek financial advice, and much of that money will end up in brokerage or savings accounts. Even better, there will be far more millionaire retirees than ever before. That means more clients for Northern Trust (NTRS), which manages money for wealthy individuals and large institutions. "It has the best business model among the trust banks," says Jason Tyler, a portfolio manager at the Ariel Funds, which holds 10 million Northern Trust shares in its client accounts. The bank has recently been gearing up to capture more boomer clients by conducting surveys on their spending habits and savings needs. "The company is very focused on going out and getting new accounts," Tyler says. While many boomers will be rich, Northern Trust's shares aren't. At a recent $43, the stock trades at a P/E ratio of 17. That's slightly less than the multiple for other money managers.

Sellers of annuities stand to benefit from retiring well-off boomers also. Over half of all annuity assets are held by people over 65. While an annuity is a costly way to save and invest, it allows retirees, who like the predictability and safety of a paycheck, to turn their assets into guaranteed monthly income. Lincoln Financial (LNC) has been one of the most aggressive marketers of a new breed of annuities that provide a monthly income stream and, unlike traditional annuities, allow the holder to retain control over how his principal is invested and to bequeath untapped assets to heirs. Insurance analyst Colin Devine at Salomon Smith Barney says rising demand for these annuities will lead to a huge windfall for Lincoln. "If you can solve individuals' income needs, then they will hand over all of their money," says Devine, who is recommending Lincoln's shares. At $48, Lincoln Financial has a P/E ratio of 11 and a dividend yield of 3%.

Could Crash but Won't

Returns have followed the rise of an age group that will soon decline...

...but younger workers who started saving earlier than boomers...


...will use more generous savings plans, creating demand for stocks.

NOTES AND SOURCES: S&P 500 data as of Feb. 17 from Thomson/Baseline; adjusted for inflation using CPI data from the Bureau of Labor Statistics. Population data from the U.S. Census Bureau, CPS Reports P25-1130 and MIT economist James Poterba. Retirement savings data as of 2004 from the Transamerica Center for Retirement Studies. Maximum 401(k) contribution figures through 2006 from The Hay Group.