A Demographic Case for Why Rates Won’t Rise
For more than 30 years, interest rates have been falling in the US. It’s hard to believe, but back in 1981 you could have lent money to the US Government for 30 years and earned more than 14% per year. For comparison, the same 30-year government bonds pays about 3% interest today.
Because most retirees rely on fixed income to support their lifestyle in retirement, this trend creates a real problem for current and future retirees. Back in 1981, $100,000 invested in “risk-free” government bonds would produce $14,000 per year in income. In order to generate the same $14,000 income today, a retiree would need to invest more than $466,000 in the same government bonds.
Few retirees purchase treasury bonds to fund their retirement. However, treasury bonds tend to be the yardstick that all other investments are priced off of. So, if rates on treasury bonds are low, you typically see lower rates of return on other investments as well.
For years now, economists and investment professionals have been arguing that interest rates are going to rise. This could be painful for anyone who currently own bonds because bond prices move in the opposite direction of interest rates. However, higher interest rates would be a welcome sign for future retirees because their nest egg will be able to generate more income during retirement. Unfortunately, those future retirees might not be so lucky.
Over the long run, interest rates tend to track economic growth. So, if the economy is expanding at a rapid pace investors are less interested in owning safe treasury bonds. In this scenario, the limited demand would cause bond prices to fall and interest rates to rise. Alternatively, if the economy is beginning to slow, there are fewer good investment options available, and more people will opt for the safety of treasury bonds.
The chart below shows the annual change in Gross Domestic Product (GDP) and the interest rate of the 10-year US Treasury bond. Notice that back in the early 1980’s when interest rates were above 10%, GDP growth was also above 10%. During the 1990’s, both fluctuated between 5–7%, and more recently between 2.5–5%. So, faster economic growth equals higher interest rates.
The US Economy is the largest in the world, and roughly 70% of the US Economy is consumption. Consumption is a pretty broad category but it’s most of the things we consumers spend our money on: groceries, cell phones, eating out, vacations, gasoline, automobiles, and even houses. Simply put, the spending habits of consumers has a significant impact on the pace of economic growth.
Consumption is largely a function of someone’s age. The average 25-year-old makes less than the average 50-year-old, and as a result, has less money available for consumption. The government spends a lot of time researching the demographics of Americans. Below is a chart the shows the average income and spending of different age groups. Not surprisingly, those people between the ages of 35 and 55 make the most money. These are considering our peak earning years. It’s no coincidence that those age groups also spend the most money as well. As Americans age and settle into retirement, their income and expenses decline.
According to a Pew Research Center study, 10,000 baby boomers will reach full retirement age every day until 2030. That’s more than 47 million people that will retire over the next 13 years. Those 47 million people, on average, will spend less in the future and will weigh on future economic growth. This is not a new statistic. It was actually first published back in 2010.
As a result of the aging baby boomers, the total number of people in their prime working years hasn’t grown since before the Global Financial Crisis. Below we look at two segments of the US Population; those people between the ages of 25 and 55 years old, and those people over the age of 55.
Notice that during the 1980’s when interest rates and GDP growth were high, the number of people between the ages of 25 and 55 was growing at a rapid pace. In fact, during the 1980’s, the number of people in this age group grew by more than 2 million people every year. That’s the equivalent of adding a new Houston Texas, the fourth largest city in the US, every year. Or, a new Los Angeles, the second largest city in the US, every two years.
It’s impossible to predict where interest rates will be in the future. However, all things being equal, the demographic trends in our country aren’t arguing for higher rates. If rates continue to stay low for a prolonged period of time, retirees will likely need to recalibrate their income expectations during retirement. Additionally, those who have yet to make the leap into retirement might need to rethink just how much they’ll need to have saved before they “punch the clock” for the last time.