Managing Longevity Risks and Opportunities
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Shelly Kagan is Clark Professor of Philosophy at Yale, and he teaches a great class about death – PHIL 176: Death. You don’t need to have high SAT scores in order to attend this class, nor do you need to reside in Connecticut. Using the power of the Internet, anyone on this planet can attend his course at any time. It’s freely available online. In lecture 17 of the series, he talks about why death is considered to be so bad, which helps explain the appeal of longevity. Aging has always been the ultimate evil, unless Dr. Kagan can convince you otherwise (he gives it a pretty good go in his lecture series). According to experts like Margaretta Colangelo, longevity also represents the investment opportunity of a lifetime. And she’s not the only one that thinks that.
“Longevity is the economic opportunity of our lifetime” Andy Sieg, president of Merrill Lynch Wealth Management.
Aging Analytics Agency published an 83-page report which talks about the financial implications of longevity for all the various stakeholders in the financial industry, from insurance companies to asset management firms. For example, asset managers need to make it easier for investors to invest smaller amounts in order to increase diversification.
Seems like they’ve listened, as all the major brokerage firms have now dropped commissions entirely as the industry rapidly consolidates. For institutional investors, expect to see the emergence of “Fintech 2.0,” a term Margaretta has coined for financial products that cater to the 60+ crowd with expected lifespans exceeding 40 years or more. Today, we want to look at the opportunities and risks that longevity poses for retail investors of all ages – like your average Joe out there with a 401K, a mortgage, and 2.5 kids.
The Longevity Opportunity
Like many disruptive themes, the longevity opportunity is one that caters largely to institutions that can capitalize on an increased human lifespan in a variety of ways. For retail investors, the opportunity – at least for the moment – is largely confined to retail investment products like stocks or ETFs that can be accessed through brokerage firms. For example, page 56 of the aforementioned report talks about “Investment Opportunities with Exposure to Longevity Trends” which are listed as follows:
For each of the above categories, you will find stocks out there that provide some pure-play exposure. For retail investors, these are the “opportunities” that the longevity industry offers. As with any investing theme, things rarely pan out as expected. If you plan to invest in these “opportunities,” allocate a small percentage of your capital to the thesis and don’t put place all your bets on one single stock. Diversification is your friend.
If you had to summarize the longevity opportunity for retail investors, it might be to invest in healthcare stocks and ETFs as people will need a whole lot more care the longer they live. While a smaller set of retail investors may avail themselves of longevity’s “opportunities,” all retail investors will be subjected to longevity’s risks.
The Risks of Longevity
Let’s start with your average Joe who is planning for retirement. There’s something called the 4% rule which says you should have accumulated enough wealth such that you can withdraw 4% of your portfolio each year in retirement for a comfortable life. To put some clarity around that rule, studies have shown that “even during untenable markets, no historical case existed in which a four percent annual withdrawal exhausted a retirement portfolio in less than 33 years.” That may be the case, but what happens to that rule in the face of a dramatic increase in life expectancy?
Now, in Switzerland, every second baby is expected to have a life of more than 100 years.” Klaus Schwab, Founder and Executive Chairman of the World Economic Forum
There’s also another problem with traditional retirement planning that may not be so obvious.
The Problem with Fixed Income
The emergence of robo-advisors like Betterment provides the average Joe with a way to invest for retirement without paying exorbitant fees to a human adviser named Alistair who wears a Ferragamo tie and who rode the train to work to give financial advice to someone who drove up in a Bentley. The traditional investment advice that’s doled out by robo and human alike is the notion of shifting your investment mix from “90% stocks, 10% fixed income” to “90% fixed income, 10% stocks” with the weighting moving to almost all fixed income by the time you retire. (Fixed income simply represents an asset you own that pays a fixed amount of money – called a coupon in bond lingo – for a fixed duration.) Here’s an old adage as to how you ought to shift your assets from stocks to bonds as you age.
The problem with fixed income is that it’s fixed, while prices aren’t. That’s the problem with inflation. A dollar today is worth much more than that same dollar ten years from now.
Another not so obvious factor in life quality is the likelihood of children providing for their parents in old age. Spend some time among Hongkongers or Filipinos and you’ll quickly see how some collective cultures prioritize taking care of the elderly above all else. Longevity is much less of a problem when you have children who are capable of providing for you when the money runs out. So, maybe it’s best you hug your children more and teach them about a concept that helped the Oracle of Omaha become one of the richest men on this planet.
Dividend Growth Investing
Perhaps the most effective investment strategy to offset the risk of living 120 years might be dividend growth investing. We’re going to stick with our healthcare theme and talk about a stalwart dividend growth stock – Johnson & Johnson (JNJ). This is a company that has not only paid a dividend for 57 years in a row, but increased that dividend check for 57 years in a row – every single year. Think about how many recessions they’ve weathered while being able to give their investors a raise for 57 years in a row. You bust your ass at your job, day in and day out, spending the majority of your waking hours making someone else wealthy, and they don’t even have the decency to give you a raise every year. Johnson & Johnson does, and they’re in an excellent position to do that for years to come.
A typical response you get from investors about JNJ is that their yield is too low – around 2.68% now. That’s true, but you need to take into account the rate at which that dividend will grow. For the past 10 years, that dividend has grown an average of 6.9% every year. That well outpaces inflation, which means your quality of life increases as each year passes. That’s just one example of a dividend growth stock, but there are many others across more industries than just healthcare. Putting together a portfolio of dividend growth stocks gives you a set of income streams that increase over time meaning that every year that passes, your quality of life increases. That’s a great way to hedge against the risk of longevity.
Longevity Investment Products
In order to provide investors more options in the face of an increased lifespan, Margaretta and her team are building investment products that cater to longer-term horizons. We’re planning to take a closer look at these to understand the underlying mechanics of these products. You’ll also see other investment companies building thematic ETFs around longevity, like Global X’s Longevity Thematic ETF (LNGR). A cursory look at these ETFs shows an actively managed portfolio of healthcare stocks that you’re paying higher fees for someone to manage. When 80% of active fund managers can’t beat a benchmark, what makes these fund managers any different? Seems more prudent to just invest in a low-cost healthcare sector tracker ETF like the Vanguard Health Care ETF (VHT) which will provide similar exposure at a much lower cost.
Conclusion
Forgetting about longevity for a minute, there’s a retirement crisis in America at today’s life expectancy. Says an article by CNBC, “At Vanguard, the median 401(k) account value for an investor age 65 and older is a measly $58,035.” Even if you only have ten years left, that’s about $483 a month. Hopefully that social security fund doesn’t run out because a lot of people will be living some extremely miserable golden years if it does.
While Americans may be scrambling to catch up just to solve for today’s life expectancies, their children can be taught not to make these same mistakes. That’s where prudent boring strategies like dividend growth investing can be taught to today’s youth as soon as they start making money. Speculating on what Tesla shares will do next week is exciting and all, but real wealth creation is boring. Real wealth creation happens while you sleep, and strategies like dividend growth investing will make sure you sleep well at night knowing that your quality of life gets better with every year that passes.
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