Aging Populations Can Prosper, or Not: Making the Right Investment Choices

The U.S. population is getting older as the "age wave" of baby boomers nears retirement. Will their 60s, 70s and 80s be happy years, marked by prosperity, good health and fulfilling activities?

There's every chance of that, according to two keynote speakers at Wharton's 2007 Economic Summit: Wharton finance professor Jeremy Siegel and Michael Milken, the legendary junk-bond king who now heads The Milken Institute, a non-partisan think tank.

Creating a New Middle Class

Siegel, known for his two bestsellers, Stocks for the Long Run and The Future for Investors: Why the Tried and the True Triumph over the Bold and the New, said that boomers now accumulating assets to fund their retirements are enjoying market conditions that are "very favorable for equities."

Today, the ratio of share prices to the previous 12 months' corporate earnings is about 15 to one, in line with the average over the past 130 years. Flipping the calculation, to divide earnings by share price gives an earnings yield of 6.75%, showing why stocks are competitive with bonds currently yielding around 5%, he said.

Moreover, the long-term P/E average of 15 may be out of date because the markets have evolved. Brokers' commissions and other transaction costs are lower than they have ever been, and investors can now diversify their holdings among stocks issued all over the world, he noted, suggesting that American investors should have about 40% of their stock holdings in foreign issues. All these market changes have reduced stocks' risks and price volatility, he added.

"Lower volatility argues for higher prices on risky assets," Siegel said. Hence, the proper P/E ratio for stocks is now about 20. Stock prices could therefore rise by about a third, taking the P/E from 15 to 20, even if corporate earnings did not grow. But rising investment returns do not guarantee prosperity. As Americans live longer but retire earlier and earlier, the result is "a dramatic increase in the time in retirement," making the financial challenges ever more difficult. "The question is, can this trend continue?" Siegel asked.

With a larger portion of the population retired, it will get harder for American workers to produce enough goods and services. Nor will the young have enough money to purchase the investments accumulated by retirees. If demand is too low, retirees will not be able to convert their stocks and bonds into sufficient cash to fund lengthening retirements. "You cannot eat your stock certificates," Siegel said. "If there are not enough people willing to buy your assets, you are in trouble." People could retire later -- perhaps not until age 76, he said. But not many find this appealing.

On the other hand, Siegel added, "there is a possibility we can sell to the younger workers in the rest of the world." This assumes continuing economic advances in developing countries, creating a middle class wealthy enough to invest in stocks, bonds and other assets. That demand would shore up prices of Americans' holdings and provide buyers for those who need to convert investments to cash.

Current trends are promising, Siegel said, projecting that in 2050, the developing world will account for three-quarters of the world's economic output, compared to one-half today. "By the middle of this century, the developing world will own most of the world's capital," he noted, describing recent gains in countries like China and India as "just the tip of the iceberg."

As more foreigners get wealthy enough to become investors, Americans could continually afford to retire younger and younger, he said. The chief threat to this outcome is protectionism in the U.S. and other developed countries. That would raise the cost of goods and services in developed countries and retard growth in the developing world, leaving American retirees without enough buyers when they want to liquidate their assets.

If protectionism is averted, the future looks bright, Siegel said. "I'm an optimist today. And I will be an optimist in the future -- as long as we keep the capital markets open."

400-pound Football Players

Unlike their parents and grandparents, many baby boomers will never retire in the traditional sense, said Milken, who argues that this is all to the good. "They are young, and they are going to stay young. Medical advances are just one factor, he noted. In addition, attitudes have changed. Decades ago, the media portrayed women in their 40s and 50s as elderly; now it shows them as young and active. "So, yes, it's good news. Eighty is the new 60... Sixty is the new 40."

Gradually, people will do different kinds of work than they do today, and work will move to new locations, he predicted. In 1975, it cost $10 a minute to phone India from his trading desk in the U.S., he recalled. Now it costs 4 cents. With cheap communications and the Internet, more people will telecommute, providing work opportunities for people who are not ready to retire completely.

One of the biggest changes in the working world will be the continued shifting of jobs from developed countries to developing ones. While many American workers worry about this, Milken does not. In fact, he expects many skilled jobs to follow the unskilled jobs that have moved overseas. In 2004, he noted, about 150,000 non-Indians went to India for major medical treatment, including heart transplants -- a trend he expects to continue.

People in developed countries will benefit from globalization by getting low-cost goods and services. And prosperity in developing countries will produce markets for goods and services produced by developed countries. Also, the developed countries are rich in human capital, the most important component to prosperity, Milken argued. They will find ways to replace lost jobs with better ones, just as farm workers did when they lost jobs to agricultural mechanization and moved to factories.

The key to prosperity is investment in human capital, primarily through education. Historically, countries that invested this way prospered the most, Milken said.

For hundreds of years, China was one of the world's economic powerhouses. That changed in the 14^th century when the Ming dynasty turned inward and emphasized an agrarian economy. China is now returning to economic dominance, largely because it has renewed investment in human capital. By 2025, Milken noted, China will have more English speakers than the rest of the world combined.

He also predicted that innovation will help many countries prosper even if they do not have the vast resources and work forces of countries like China and India. The Netherlands, he recalled, became a global economic powerhouse hundreds of years ago because it created the idea of the publicly owned company. That attracted far more investment capital than could be provided by the traditional funding source, the crown, he said.

In more recent times, prosperity has been spurred by innovations that allow a more efficient use of capital -- collateralized loans, the bundling of loans for sale to investors through securitization and easy-credit instruments like credit cards, he noted, adding that human capital is increased by importing skilled people, educating the population and improving the quality and length of life.

And yet, Milken cautioned, it is easy to make mistakes. American students are not testing as well as students in many other countries. One factor: The best college students are not becoming teachers, partly because women now have many other career opportunities.

And, despite enormous medical advances, Americans' health is not improving as it should, largely because of the unhealthy eating and inactivity that the culture encourages. In 1980, he noted, not a single National Football League player weighed over 300 pounds. In 2006, more than 300 of them did -- and some players are now trying to top 400 pounds.

When it comes to investing in human capital, the wrong choice can have damaging consequences, Milken warned. In 1960, for example, Singapore and Jamaica were similar -- small, tropical countries with few natural resources and per-capita incomes of about $1,900 per year. Subsequently, Jamaica emphasized an economy based on agriculture and tourism, while Singapore invested in education and industry. Today, Jamaica's per-capita income hovers around $4,000. Singapore's is $29,000.

Countries that fail to learn from such examples will find themselves in trouble, Milken said. "This century will be defined by the competition for human capital."

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