Retirement: Emerging markets to the rescue?
As retirement approaches, millions of baby boomers do not have the savings they need to live well in their golden years. The reason for this may not only be because some didn't start early on their retirement planning -- but because of the catastrophic economic crisis we've had to face. Some people fear the U.S. economy will not grow at a rate that will help their portfolios catch up.
But Scott Below, chair and associate professor in the Department of Finance at East Carolina University in Greenville, N.C., says retirees should not give up hope. In the second part of a two-part interview, he says economic growth in emerging markets may provide the tailwind U.S. retirees need to lift their retirement balances higher.
Because of the shift to an aging population in the U.S., Japan and some countries in Europe, an economic slowdown is forecasted in those regions. Do you think the two go hand in hand?
An aging population does act as a drag on an economy, and it also creates problems with government programs such as Social Security and Medicare systems. With far more money flowing out of those programs to retirees than into them from the active workforce, that's obviously a problem.
The good news, however, is that the American and European economies aren't as dominant globally as they once were. Some may not see that as good news, but it's not about America being in decline -- it's about undeveloped and emerging economies being on the rise.
We live in a truly global economy today, and one that will only become more global going forward. That's actually good for America, because American corporations are taking full advantage of the growth we're seeing in places such as China, India and South America, and that's creating jobs in the U.S. So while an aging population does create some headwinds for the U.S. economy, they could be more than offset by the world's emerging nation economies.
Should Americans invest more retirement money in emerging markets than they have in the past, since countries that are not yet mature have more growth potential?
Yes, they should, but only if they can overcome the emotions elicited by high-volatility assets. Studies show investors tend to sell most heavily after large drops in stock prices, and they buy most heavily after large stock run-ups, which is obviously the exact opposite of what they should do.
Selling after big drops is based on fear, of course, and we saw a perfect example of that in late 2008 and early 2009. Panic-selling drove stock values down to ridiculously low levels, where some companies were trading for prices below the value of the cash they had on hand. That's precisely when you should be buying those stocks, but instead we saw massive net redemptions from stock mutual funds in people's 401(k) accounts.
Unfortunately, many of those folks are still on the sidelines in cash or low-yielding bond funds, while stock prices have more than doubled since. Those 401(k)s will never make up for the losses they locked in by panic selling, and for many people this will mean delaying their retirement.
So my main concern with individual investors owning emerging-market stocks is that these assets are significantly more volatile than domestic stocks, giving investors even more opportunities to panic-sell following dips. There is little doubt emerging-market stocks will grow faster than domestic stocks over the next 20 years, but if you can't handle the roller-coaster ride, you're probably better off opting for something a little less emotionally taxing.
What's the right amount of money that people should save for retirement on a percentage basis? Should it be 10 percent, 15 percent or 20 percent?
I don't think there is any single "right" amount -- it's different for everybody. There are so many factors you need to consider, such as what rate of return your investments will earn, how much you'll make, and how early you start saving.
The best option is to start as early as you can and save as much as you can. The later you start, the more you will need to save percentagewise because you'll get less help from the power of compounding.
It's also important to invest wisely, with a long-run mentality. Younger retirement savers will obviously want to have higher allocations to stocks than older savers, but even those in retirement should still hold at least some stocks, because the growth that stocks provide over time will help reduce the likelihood people will outlive their nest egg.
We're all living longer, which is good, but it also increases the chance that we'll outlive our retirement accounts, which is not so good. The only way to avoid outliving your assets is to retire with more money than you'll need … and the only way for most people to achieve this is by living frugally and investing as much as they can.
We would like to thank Scott Below, chair and associate professor in the Department of Finance at East Carolina University in Greenville, N.C., for his insights. Questions for this interview were contributed by Barbara Whelehan, assistant managing editor at Bankrate.com.
Read the first part of this interview.