You Don’t Have As Much Retirement Savings As You Think!

Many people. especially those in the baby boom generation, have this perception that the world is awash with savings. Yes, the post-war generation is wealthier than any before it. But the ultimate value of any investment depends upon being able to convert it into cash, to be able to realise its purchasing power. According to a recent Global Wealth Report by Credit Suisse, the world’s accumulated wealth – around $250 trillion – is almost certainly incapable of realisation at its paper value. This headline number thus vastly overstates the supposed savings glut.

Why are savings figures so vastly overstated?

Most of the worlds savings are held in two forms:

  1. Real estate – primarily primary residences
  2. Retirement portfolios – invested in stocks and bonds.

Both are rising in value. A combination of higher incomes, population growth, lower interest rates, increased access to credit, and in some cases, limited housing stock have driven up home prices; those who got in early have done especially well. Meanwhile, increased earnings and dividends, driven by economic growth and inflation, have boosted equity values. So have loose monetary policies designed to counteract the Great Recession of 2009.

So whilst on paper your wealth might be rising due to higher house prices, this does not automatically translate into purchasing power. Most people planning for retirement put there primary residence in the asset column whereas in reality they should stick it on the liabilities side. Think about it for a second. The house you live in produces no income. On the other hand, maintenance costs, utility bills and property taxes – which ofter rise along with house enriches – mean that houses are cash flow negative.

Realising value from you property in retirement

Now most people will not follow this train of thought that your primarily residence should not be included int he assets you have for savings and retirement purposes. They will quickly bring up genuine points like equity release and being able to minimise gains on the property by borrowing against the value of the property. But those loans cost money to service and they expose owners to fluctuations in property prices.The property can always be sold, of course. But much of the profit is likely to be eaten up by transaction and relocation costs – not ot mention the cost of a new home, which will also have risen in value.

High property prices depend on their being enough potential buyers who can afford the increasingly large mortgages that have helped boost real estate values overt he past couple of decades. Their numbers may be shrinking: stagnant incomes, the decline in secure longterm employment and the rise in contracting jobs all undermine the appetite and ability to borrow. Demographic changes and new barriers to immigration will shrink the size of population as a whole. Similar considerations apply to real estate investment.

Shares in your retirement scheme

As with your residential property, the total value of your shares in your retirement portfolio might not reflect their true economic value at the moment. Share prices have been distorted over the past few years by quantitative easing and low interest rates thus giving them a higher value then they ought to have. This might sound confusing but read the reasoning below.

Share prices reflect the future rather than current earnings streams of corporations. Low interest rates, which have to rise eventually, have artificially increased the discounted value of these cash flows. Much of the gains merely reflect higher Price Earning multiples, not higher revenues and earnings. Slower growth and lower inflation mean future income streams may be weaker.

In the past few years, equity valuations have also benefited from the rising share of national income captured by corporate profits, which may be unsustainable. Debt-funded share buybacks and corporate activity that boosts valuations – including mergers – may slow. Companies can’t repurchase more than a certain level of outstanding shares if they want to maintain their stock-exchange listing and trading liquidity. Mergers eventually may run up against competition concerns.

Whilst there are confers revolving around inflated stock prices at the moment, they are nothing compared to fixed income securities (bonds). Bonds used to be a safe heaven asset but this has changed in recent years thanks to the credit quality of government and corporate bonds declining. Additionally, regulatory changes mean that bank-issued bonds may be written down in cases of financial distress. With investors having assumed more risk to compensate for falling returns, they face increasingly uncertain returns on capital.

The baby boom time bomb – further falls in stock prices

Much of the equities wend today belong to the retirement accounts of the baby boom generation. As many ageing investors belonging to this generation are set to draw down on those savings in order to fund their retirement, we could see asset prices starting to fall in the years ahead.

When the boomers retire, we can expect to see withdrawals from various asset classes being far larger than any inflows from younger generations. With larger selling activity and lower demand for property, equities, bonds and other assets, the natural conclusion can easily be drawn.

An important factor is changing funds flows. Rising wealth, in part supported by forced or tax-incentivized pension savings, created strong markets for financial assets in the postwar era. Now, many aging investors are set to draw down on those savings at the same time to fund their retirement. Given fraying safety nets across the developed world, those withdrawals could well be large — indeed, greater than new inflows. That will reduce the funds available for investment, as well as demand for property, equities, bonds and other assets.

The inability to convert investment into cash at current valuations means that individuals may be a lot less wealthy and have a lot less savings than they assume. If you are approaching retirement in the next couple of years, this is something that you really need to think about. When looking at the assets you have stuffed away for retirement, discount their values in order to give yourself a more accurate depiction of their value when you come to dispose of them as cash. By taking this step and planning now, you could well avoid a major catastrophe further down the line.

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