Any serious discussion about the management of wealth or how to invest should begin with a basic understanding of human behavior, of when and why people do things. This basic understanding includes two simple insights: that human behavior is measurable and that it is predictable.
If you know the size of a population–for example, that of the entire United States–you can then quantify, calculate, gauge, and determine probable outcomes based on the predictability of that population. According to reports from the U.S. Government, the predictable spending behavior of the U.S. population drives 70% of our economy. The U.S. Department of Labor conducts an ongoing Consumer Expenditure Survey that measures how much people spend per year, down to the penny, on over 1000 different items. Likewise, this collection of numerical data shows how, in very predictable ways and at predictable ages, consumers greatly reduce spending. (You can access this survey at www.bls.gov/cex/.)
If you know when specific populations enter the workforce, when changes in the workforce take place, when spending is at its peak and when people are spending money on houses, cars, travel, healthcare, etc.–and the opposite–you can make some predictions with a fairly high probability of success.
Let's use the average adult female for a snapshot of these patterns. At 25 years of age, the average woman marries, purchasing wedding-related goods and services. She has her first child at age 27, when she buys child-focused items such as baby food and clothes. She'll close on her first home at age 31 and will fill it with furniture and other home-related products. Her child is now 14 and at the peak of his calorie intake, eating her out of "house and home." This is why the largest purchaser of potato chips is a 41-year old woman. Corporate America bases much of their product marketing decisions on the same consumer spending data down to the zip code and neighborhood block.
At age 43, the woman has enough home equity and income to sell her first house and move on to a larger, more expensive home–probably the largest and most expensive one she'll ever own. She spends the next three years purchasing more high-end goods than she likely ever will again, including extensive new landscaping, furniture, and a luxury car.
In the meantime, her teenager turns 19 and is ready to enter college. The woman's belt tightens as hefty tuition bills arrive and retirement looms closer. Next, her retirement clock starts ticking, the woman's saving habit kicks into overdrive beginning at around age 55, and she continues to save until she retires at age 65.
Peering into the Crystal Ball
Just as we can predict the types of products and services that consumers buy at certain ages, we can also determine the quantities of those products and services that will be bought and sold by studying U.S. census data. The Census Bureau literally goes out and counts people. Corporate America then bases product-marketing decisions on the data drawn from this amalgamation of zip codes and demographics. Your local grocery chains use the data to determine when to open new stores in a particular area, when to close stores in others, and how to re-stock store shelves as their local shopping populations mature. It's not a coincidence that a huge number of teenagers live in my own neighborhood and within a two- mile radius we have a Super Safeway, a Super King, and a Super Albertson's.
Since these predictable spending patterns affect company earnings, and company earnings are reflected in the price of publicly held stock, observing these patterns can provide a window into the future. Why then aren't we as an industry using this type of knowledge to manage our client's wealth? Why are we stuck in a world that can't mention the words "predict the future" then turns around and bases investment decisions on past performance? Two reasons: the first goes back to the day when investment management was about "do no harm," and the second is that historical trends are easier for us to summarize and explain to our clients. As an industry we tell people that no one can predict the future–a statement often followed by advice on where to invest.
Past performance operates much like the odometer on your car. An odometer looks backward; it isn't designed to tell you how many more miles are required to reach your destination, or other helpful information. Historical data on investment vehicles has some value but it is in reality, just like the odometer, a picture of the past. It would be more useful to have an odometer giving a fair estimate of how many miles to your destination versus your current fuel level. What would be more useful than a graph historical investment returns would be a tool providing a fair estimate of what might reasonably be expected in the future, which is what the consumer spending data does.
Spending data does have an impact on the future, yet it isn't factored in to risk return graphs, style analyses or Morningstar data, all of which is based primarily on past performance. These types of strategies are based on predicting winners from past performance. Historical performance has become so hardwired into the investment profession's delivery system that we need to stop and think about it. This approach creates frustration for investors who become, in effect, market timers–often firing investment advisors and hiring new firms in hopes of gaining back lost ground; the classic buy-high, sell-low syndrome results. Finally, investors become disillusioned with the never-ending process of picking new actively managed investments, and some give up altogether.
I believe we must start taking responsibility for the future and stop using past performance as an indicator of what could be. Instead, we should stand up and say what we see: that certain patterns do have predictable outcomes. Take healthcare for example, I believe the next big spending spree in the U.S. will occur in this area. All you have to do look around and see that our population is getting older, then let your brain link old age to healthcare. You don't need an economist to tell you this.
I hope you're starting to see why this information is so important to you and your clients.
In our current financial environment of inescapable media exposure, conflicting and/or inane information carries the same weight as valuable information. As a free society, we are privileged to have total availability and disclosure of all information, but that also includes worthless opinion and sales hype. We need to educate ourselves in order to make "intelligent" investment decisions and have the discipline to help eliminate bad ones. By the way, you won't find the following factors studying modern investment or academic theory, or by reading the popular bestselling investing books.
Registered Births 1910-2004
Birth Rate
The National Center for Health Statistics (NCHS) tells us how many people are born. Birth rate determines the size of a generation. Thus, birth rate charts tell us decades in advance when new generations of consumers will move through predictable earning and spending cycles.
The above graph tracks birth rates since 1909, which is when birth data began being collected on a yearly basis. Our population appears to have peak growth in 40-year cycles. There was a peak in the birth cycle in 1921 that has been dubbed the 'Bob Hope' generation; and another in 1961, well known as the Baby-Boom generation. The 'boomer' generation is notably over four times the magnitude of the past generation and overshadows its own offspring generation. Our baby boomer generation is so massive that everything it does has stretched our society and economy to extremes.
What's Behind Us Is the Future!
A large group of people (boomers) is moving forward in time, which indicates a large drop in population (less people to spend). What that means is that advisors still relying on so-called 'life stage' allocation charts that suggest client age, emotional state and time horizon are the criteria with which to prescribe the right investment strategies or vehicles is, they could easily decimate their clients' portfolios.
