Will boomers cash in?

Baby boomers have triggered social change at each stage in their lives - from expanding school rolls to inventing the yuppie. Now, they're reaching a milestone that has some experts worried.

The first boomers turn 59-1/2 this year. That's old enough to pull money out of Individual Retirement Accounts (IRAs) without tax penalty. And while no one expects a huge drawdown immediately, some financial analysts are concerned about what boomer retirement will do to the stock market.

Call it the cash-in crisis of the early 21st century. If the nation's 80 million boomers fund their golden years by pulling their trillions of dollars out of stocks and bonds, markets could tumble, some experts say. Others counter that the threat is overblown because markets are far too complex to judge using generational shifts alone.

This debate is heating up as boomer retirements loom. In just three more years, the first boomers will be eligible for early Social Security payments. Three years after that, they'll reach the classic retirement age of 65.

"There's a lot of evidence that people do take Social Security benefits at age 62 when they're first eligible" and leave the workforce, says John Gist, associate director of the Public Policy Institute at AARP, a seniors' lobby. There's also a strong tendency for people to take lump-sum distributions from IRAs and pension plans, he says, "and there's a danger that they'll spend a lot of it and won't have enough left for their retirement needs."

The big question is: Will boomers act any differently when they reach 62?

The generation is closely watched because of its outsize impact. It's 50 percent larger than the previous generation and one-seventh bigger than the following one. By 2030, when all boomers will have reached retirement age, the share of Americans over 65 is predicted to jump from 17 percent in 2000 to 27 percent.

That spells demographic trouble, according to some analysts. In their view, the stock market boomed in the 1990s because that was the period when many boomers moved into their peak years of earning and stashed away money for retirement.

Over the next four years, boomer demographics will continue to help fuel the stock market, pushing the Dow Jones Industrial Average to a record high of about 36,000, forecasts Harry Dent Jr., an author and futurist. Then, he says, the market will collapse backward into a depression until the boomers' children hit their own peak earning years a decade or more later.

Even a much less dramatic scenario could nonetheless have big effects. Since the 1920s, stocks have returned each year an average 6 percent above bond yields, notes John Geanakoplos, director of the Cowles Foundation at Yale University. But because of boomers retiring, average stock returns for the next 15 years or so will be weak, he predicts, maybe only 2 percent a year above the yield on bonds.

Despite these arguments, many economists remain skeptical that demographics tell the whole story.

"Markets are more robust than that," says Leonard Burman, a senior fellow at the Urban Institute. "If baby boomers decide to shift out of stocks and into bonds, then bondholders will shift into stocks" because stocks would be undervalued, he says. In addition, "we've got a huge number of international investors, and they're not affected by the same factors as domestic saving and investment. I don't see there being a very large effect."

Such demographic changes also will probably trigger other forces that could mitigate the overall effect, other analysts say. For example, lower returns on market investments could push baby boomers to retire later, which would reduce the amount of money siphoned out of the market in any one year.

Interestingly, surveys show that most boomers already expect - and often desire - to continue working past 65. When financial planner Richard Erwin talked with baby boomers 10 years ago, a lot of them mentioned early retirement. Not any more. "They say, 'I might have to work until I'm 70,' " says Mr. Erwin, president of Investors Asset Management in Plano, Texas.

Actually, boomers may be working until age 71 or 72 whether they like it or not, add economists Anne Casscells and Robert Arnott. That's what they say is needed to maintain today's "dependency ratio" - the number of nonworking people, including retirees and children, per working person.

With little change in the retirement age, that ratio is expected to move up quickly and dramatically for three decades starting in 2010, with a massive influx of nonworkers. These nonworkers would be sellers, not buyers, of stocks, driving prices down.

"Our guess is that getting poor investment returns [in the future] is fairly likely, and it would be part of this process of people working longer," says Ms. Casscells, a managing director of Aetos Capital in Menlo Park, Calif. As retired boomers sell assets to buy goods and services (such as $1 trillion or more per year in healthcare services), demand pushes up prices and wages for the relatively smaller workforce, creating inflation. Because boomers' savings now can't buy as many goods and services, they will hesitate to retire as early or go back to work.

If boomer savings are smaller because of poor investment performance, as some forecast, that also would delay retirement. In this scenario, "When you're 64, and you take your 401(k) [retirement savings plan] to your financial planner," Casscells says, "your financial planner says, 'This isn't going to cut it.' " So it's back to work.

Those born between 1910 and 1940 may turn out to be the "golden generation" of retirees, enjoying an average of 16 to 18 years of retirement if they made it to 65, funded by a huge cohort of baby-boomer workers, say Casscells and Mr. Arnott, chairman of Research Affiliates in Pasadena, Calif. Boomers should expect about 12 years of retirement, based on retiring at age 72, they say.

Though some people will stay invested in stocks throughout their lives, poor market performance could become a vicious cycle for boomers. If they have had a poor experience with the stock market during the years they are contemplating retirement, Casscells says, "they're likely to say, 'Forget about this. Just give me something safe' " with a fixed return - causing yet more selling.

In theory, since these demographic changes have been known for years, markets should have already taken them into account. But research published last year by Stefano DellaVigna at the University of California at Berkeley and Joshua Pollet at the University of Illinois suggests that both institutions and individual investors are shortsighted, looking only about five years ahead in assessing stock values. That window is about to include the first wave of boomer retirements, which investors now may begin to weigh when making investing decisions.

Others add that the cash-in crisis fails to take into account immigration of new workers into the United States, which will help keep the dependency ratio manageable. But Casscells points out that immigration rates would have to quadruple during the next 25 years to keep the current worker/nonworker ratio in balance.

Another mitigating factor: Empirical data suggest that financial assets "decline only gradually during retirement," says James Poterba, an economist at the Massachusetts Institute of Technology, in a 2004 paper. "The evidence suggests only modest effects, if any, of a changing demographic mix."

And since boomers were born over an 18-year span (1946 to 1964), that will spread the effects of their retirement even further, Mr. Gist says. The peak birth years didn't arrive until the mid-1950s, meaning the biggest part of the boom won't turn 65 until 2020 or so, still 15 years away. At this point, he says, "it's a tricky thing to make any predictions about."