Investing in a “New Normal”

| August 2, 2011 | 0 Comments

For those who missed my last column (available at, I wrote that I expect government spending to be cut while taxes increase over the coming years. I also mentioned that my personal outlook is for slower economic growth as the both the government and consumers “de-lever” (that is, reduce debt). Finally, with economic growth subdued, interest rates are unlikely to rise significantly, at least not until wages pick up. These factors should result in a slow-growth and low return investment environment for some time to come. The Pacific Investment Management Company (“PIMCO”) has called this the “New Normal.”

Compounding the challenge in the United States is the retirement of the Baby Boom generation. Beginning this January, roughly 30,000,000 baby boomers began to turn 65, averaging roughly 10,000 retirees every day for the next 20 years. During the last 20 years, “Boomers” have provided the greatest spending boom in history. At the same time, life expectancies are extending. For example, a 62 year old couple today has a 50 percent probability that at least one will live to age 92, and a decent shot at living past 100.

So what does this imply in today’s “New Normal”?

First, as retirees reduce consumption and add to savings, there should actually be an increased demand for stable, low-risk savings vehicles like government bonds. This has been the experience in Japan, and has helped to keep a lid on long-term interest rates even as the Japanese government has borrowed more and more money. This reduction in consumption should also reduce upward pressures on inflation. Some demographers have even gone so far as to predict outright deflation here in the U.S.

Second, longer life expectancies suggest that savers will need to earn higher real (after inflation) rates of return in order to protect their purchasing power longer. This means that the traditional investment strategy of loading up on bonds at retirement could be a big mistake. Over 30 years at just two percent inflation, the purchasing power of a fixed income stream declines. For example, today’s $50 grocery bill will cost almost $91 in 30 years.

With low yields on “safe” assets like government bonds and demand for higher yields to protect against inflation, savers are being forced to take on additional risk, such as corporate bonds, “junk bonds” and stocks. In addition, with domestic growth expected to be muted, investors are looking to find companies that earn their money abroad, either through domestic companies with significant overseas operations or by investing directly in those economies. In addition to investing outside of comfortable ‘assets classes’ like U.S. stocks and bonds, investors will likely need to expand their horizons to try to find other return streams. Investments like gold or other commodities can be expensive to make, and securitized versions of these commodities have significant downside risks, but may still be useful in a world where so many things are changing.

One final point is that investors need to look outside their local area. While local conditions may be difficult (think Las Vegas), there are other areas within the U.S. or even the world where investment outcomes could be better. As the U.S. economy evolves to adapt to changing demographics, investors will need to take a global perspective to seek better returns, even if that does come with new or at least different sets of risks.

A Certified Financial Planner™ professional can help you chart your way through this “New Normal” world.

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Category: Business

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