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The Companion Advisor: General Interest
A tale of two booms

Article provided by Mackenzie Financial

Up until recently, few Canadians concerned themselves with population trends. While we all understood the term "baby boom", not too many of us considered the impact that this extraordinarily large number of people would have on the way we will live in the future.

But now newspapers quote experts on the subject frequently and the headlines are filled with speculation about the impending demise of the Canada Pension Plan if current population trends persist. What will happen to the economy - and our individual retirement plans - as this population bulge ages?

The answer may well depend on the financial behaviour of these nine million Canadians over the next decade. Here's the background. Those born between the years 1947 and 1965 are entering a new phase of the family life cycle commonly called middle age. This phase is typically characterized by a radical change in personal spending habits. Whereas people under age 40 typically borrow more than they save, people between ages 40 and 60 usually save more than they borrow.

Waiting for the Second Boom to Arrive

By the year 2005, the baby boom generation will have made this demographic shift in full and the impact for investors in Canadian securities markets could be profound. For example, we could find ourselves living in a much lower interest rate environment. The reason being, fewer people will be looking to borrow money (they will have purchased their final home by this point) meaning the demand for loans will be reduced substantially. When combined with the predictable increase in individual savings rates (boomers will save to cover retirement costs), the slackening demand for credit may keep interest rates low.

It's also possible that some truly novel demographic trends may make savings grow at an accelerated pace. For example, no one can quite predict how the unprecedented growth in two income households may change what retirement will look like in the next century. In addition, by the year 2000 it is estimated that $75 billion of wealth per year will be transferred from one generation to the next in the form of inheritances in Canada*.

Where will all of these savings be invested? With the threat of a looming Canada Pension Plan crisis, the probable continuation of high tax rates and the possibility of low interest rates, the likely answer is investments will be made at unprecedented levels in RRSPs.

Statistics Canada's data show that Canadians contributed $19.2 billion to RRSPs in 1993. As large a number as that is, it represented only 20% of the $97.9 billion that we were able to invest on a tax-deductible basis, says Stats Can. In short, there is room for five times the current rate of RRSP savings. If the theory proves to be valid, what form of tax-sheltered savings will baby boomers prefer? Logic suggests that common stocks, which have proven to outperform other forms of investment over the long term, may become the RRSP investment of choice. If a greater amount of savings chased the same supply of stocks, a good argument can be made that future prices for Canadian equities should trend upward.

Whatever the eventual outcome, it's clear that baby boomers may carry the solution to their retirement challenge in their own pockets. If this generation is given the opportunity to increase its rate of savings and makes the most of its opportunity by prompting a second boom for Canadian equities over the next two decades, the looming Canada Pension Plan crisis may never come about.

If you are a baby boomer and you're not yet investing for your retirement, maybe it's time you gave it a second thought. The future you save may be your own.