Boomers face meagre returns on investment
The recent tirade against the Baby Boomer generation, popularised by Millennial falcon Chloe Swarbrick, has focused attention on the wealth accumulation by this now reviled cohort.
Wealth, however, brings its own challenges.
Since the GFC, wholesale interest rates have been at historically low levels. Those who have prudently saved for their golden years face meagre returns. A million-dollar deposit at a trading bank will pay a mere 2.5 per cent, and then only if you agree to lock your money in for several years. After tax that’s a return of 1.67 per cent, while inflation is running at 1.5 per cent. A net return of 0.17 per cent.
This means an actual return on a million dollar investment of $1700 a year. At call rates are effectively zero and well below inflation.
Many invested in rental properties to provide a retirement income and this has proved a wise strategy if the properties were purchased and mostly paid off. However, those seeking to enter this market today face a tougher environment.
Rental investment yields have fallen from nearly 7 per cent in 1997 to as low as 3.5 per cent in Auckland today. This lower return is before the incidental costs of dealing with tenants, property managers and recent changes to the Rental Tenancies Act. The fall in interest rates has created a massive rise in asset prices, including equities.
The NZX50 has jumped nearly fourfold since the GFC and real estate has likewise spiked. To understand what is driving this, consider a rental property as an income stream paying, say, $40,000 a year. If you buy the property for half a million dollars, you are getting a return of 8 per cent.
That’s an attractive rate, so retirees will be falling over themselves to buy it, bidding the price up. If it sells for a million dollars, then the new owners will be getting only 4 per cent. What is happening is lots of cash hunting for an investment.
A rental property is, in effect, the price you must pay in order to get young people to give you money. As demand for these payments has increased, because there are fewer young people and more older people wanting their money, the prices for houses has been bidden up. The lack of alternative investment options has exacerbated this trend.
Most commentators, including myself, lay the blame for this malaise at the door of the central bank, which has been using low rates as a means of spruiking the economy. The implicit assumption is that eventually rates will rise and retirees will be able to get a marginally better return on their investments.
Is it possible we are wrong? Former US Federal Reserve chairman Alan Greenspan has been touting an alternative explanation; our ageing and wealthy populations are seeking out annuity returns and this is causing a permanent decline in yields.
To understand this phenomenon let’s cast our minds back to the postWorld War II era. Capital was scarce and labour was plentiful. Those with cash to invest had many potential borrowers all bidding up the returns.
If you were the only person in your province handing out loans you could be guaranteed an excellent rate of interest. Half a century later every second retired Baby Boomer has become a mini finance company desperately searching for a half-decent Millennial to lend money to or invest in.
The returns to capital, when capital is abundant and labour is scarce, is going to be much reduced. The value of labour in the coming decades, especially skilled labour, is going to prove relatively lucrative as the Baby Boomers eke out whatever pennies they can from their investments. If Greenspan is correct we are facing a new economic calculus where the financial assumptions of a generation are about to be turned upside down. The ‘‘OK Boomer’’ retort could be the opening salvo in an intergenerational economic struggle the Baby Boomers are going to lose.
Half a century later every second retired Baby Boomer has become a mini finance company desperately searching for a halfdecent Millennial to lend money to or invest in.