It is common to find surveys and reports that point to the various financial risks that investors are exposed to. From economic issues to interest rates, the fluctuating price of commodities and changes to specific asset class fundamentals, there seems to be no shortage of issues -- real or potential -- to be concerned about. It is rare, however, to find reports that attempt to highlight some of the underestimated risks that have the potential to threaten financial markets.
Political risks represent the greatest underestimated risk to financial markets, according to the more than 5,000 investment professionals from around the world who participated in the annual CFA Institute Global Market Sentiment Survey (GMSS), conducted in October. Political risks, however, are inherently very difficult to gauge. They involve unpredictable variables, which impact whether anticipated threats or issues materialize or not -- and whether others emerge to take their place.
In contrast, the second-most underestimated risk around the world is as plain as day: the aging population. While the challenges of an aging population are complex, they are also very common sense.
The crux of the problem is that many individuals have an inability or an unwillingness to save adequately for the long term, leaving them unprepared to make up the difference between a government pension and what's needed to sustain a particular lifestyle. This puts pressure on governments and produces a social cost. On the other hand, governments in some countries are equally ill-equipped to take on the rising costs of pensions and entitlements, which also produces a social cost. Combined, these two factors have the potential to destabilize local, national and even global economies.
The potential magnitude of this risk has members of the CFA Institute concerned. These members include global investment professionals including portfolio managers, research analysts and C-suite executives. The perceived risk is due to the fact that countries like Japan, China, France, Spain and South Africa have populations that are aging quickly or have huge gaps in funding for pensions and entitlements. This is also the case for Canada, where 31 per cent of its citizens will be over 60 by 2050.
In April 2012, the International Monetary Fund (IMF) in its Global Financial Stability Report described the nature of the problem and the financial impact of the inability of governments to find appropriate solutions. Although the impact of aging and the inability of older citizens to cover pension liabilities may not be acutely felt in the short term, failure to find a long term fix could inflate already large public debt levels and cause long-term financial instability. An issue that exacerbates the problem is the assumption of mortality rates that may be underestimated by governments and pension managers due to the speed of medical advances and the ability of people to live longer as time progresses.
In other words, a government barely able to support citizens living to 75 or 80 will encounter serious difficulty if these people end up living to 80, 85 or 90. According to the IMF, "...if individuals live three years longer than expected - in line with underestimations in the past - the already large costs of ageing could increase by another 50% of 2010 GDP in advanced economies and 25% of GDP in emerging economies." On a global scale, that increase amounts to tens of trillions of U.S. dollars, boosting the already recognized costs of aging substantially.
Three years after the IMF's report was published, little has been done to address the issue.
The reluctance of countries to teach money and investment management in schools creates a situation where the average citizen is unable to make good financial decisions and save effectively. Furthermore, the current resources earmarked for adult financial and investor education and the manner in which it is provided does not seem to be fixing the problem. It is clear that the average world citizen does not have the tools or the mandate to prepare himself or herself for 30 or more years of living in retirement. This does not bode well for the future.
After all, it is easy for people and governments to put off future priorities in the face of immediate challenges. But the solution to the aging crisis cannot be solved by government action alone, which leaves us with two options: necessitate a change in the public's perception of who has the ultimate responsibility for funding one's retirement -- or materially downgrade our expectations for what it means to be living into old age.