Scientists around the world are largely agreed that the climate is changing and will continue to change. A few holdouts are still squabbling about what is causing that change but the actual data is hard to ignore. I’d like to discuss today as the Living Universe Foundation Economics and Finance Correspondent how economic disruption related to climate change might effect conventional and early retirements.
I’m going to define retirement as the state where active full time work is abandoned in favor of living off of passive income derived from investments, social security, and any pensions. This is largely a matter of convenience as many “retirees” find something to make at least some money at that they happen to be passionate about. I’m further going to assume that to achieve this state, a person or couple will need to have saved 25 times their annual expenses in retirement. See the Trinity Study on retirement for this “4% rule” heuristic.
There are several ways climate change might impact future stock market returns. These include loss of tax advantages, increased volatility, reduced aggregate returns, stranding of infrastructure assets, increased taxes, and more.
Loss of Tax Advantages
Governments, especially those with long coast lines are going to be in a financial crunch due to extreme weather and rising sea levels. One way they might try to alleviate some of the pressure is to roll back the tax advantages on retirement savings. This would raise a lot of revenue while being viewed as a “soak the rich” approach to raising revenue as those with limited savings would pay only trivial additional taxes if any. For someone planning a 30 year retirement on retirement savings, the hit could be substantial. This will increase your need for savings.
The greatest time of risk for a retiree is the first few years of retirement. A sharp economic downturn can reduce retirement savings to an insufficient number before compounding can take place to build a bulwark. This is commonly referred to as Sequence of Returns Risk (SoRR). Climate change could cause recessions to become more frequent and of greater depth. Thus, a typical retiree in 20 years may find themselves faced with additional SoRR.
The long term average return of the equities markets for centuries has been around 9% per year. This of course comes with a sometimes high standard deviation where the markets soar for a few years and can be devastated by events such as the Great Depression. But since the world went off gold backed currency and started using active monetary policy to manipulate the markets, deep recessions have been short lived and U-shaped. This can realistically be expected to continue. The rub is that extreme weather events and loss of useful land to rising sea levels are forecast to reduce global GDP growth, perhaps substantially in the future. There is not a strong correlation between GDP growth and stock market performance but there is between corporate profits and stock performance. The markets might simply be less lucrative in the future requiring even greater savings.
Individual assets may become stranded by climate change. This might be in the form of a factory that end up below sea level. It might be in the form of fossil fuel reserves that are no longer profitable to recover after considering carbon taxes. You could end up with investments that go to zero instead of growing and producing a passive stream of income. That is a double whammy that can derail a retirement in a hurry.
Actions To Take
Things do not have to be dire. While a lot of the conventional assumptions about retirement may no long hold true in a world with climate change, history should at least continue to rhyme. There are steps an individual investor can take to mitigate climate change risks and ensure a long and happy retirement. The time to start planning is now.
Build a Bond Tent
Dr. Wade Pfau has done a lot of research into post retirement asset allocations to determine which strategies are academically robust and improve success rates. One of his findings is the Bond Tent. Since Sequence of Returns Risk is the most relevant risk to causing retirement income failure, it is the risk that should be mitigated first. To build a bond tent, in the last few years leading up to retirement, increase your allocation to have more bonds and fewer equities. Bonds have a lower correlation to the market as a whole and tend to hold up better during market crashes. This way, you can sell down bonds in an early recession scenario while you wait for your equities to recover. You then use a rising equity glidepath throughout the rest of your retirement. Eventually, you might end up 100% equities.
Choose Sectors Wisely
Some sectors are going to become targets in a climate crisis world. Fossil fuel companies are going to political and regulation difficulties on top of a likely punitive carbon tax. Big hotel chains that are heavily exposed to coastal real estate need to be avoided.
Speculate on Green Tech
Likewise other sectors are going to be market darlings. You might want to put some of your money in Hannon Armstrong Sustainable Infrastructure Capital (HASI) to take advantage of growth in renewables. A small bet into companies research algae based fuels, advanced uses of cellulosic biomass, or new recycling methods could pay huge returns. Also, battery companies and specialty miners that extract rare earth minerals for batteries stand to be strong performers in the future.
Consider Geographic Arbitrage
One way to make your money go a lot further in retirement is to simply move. If you are currently living in a coastal area, you might be needing to move anyway. Exchange your high cost of living in the United States for a much lower cost of living in Latin America or perhaps Tbilisi, Georgia. You’ll find warm friendly people, beautiful locales, a slower pace of life, and a rejection of the consumerism that has infected Western culture. In addition, without gaggles of multi-billion dollar corporations corrupting the political process in smaller countries to maintain the status quo, local governments might be able to respond to the climate crisis more nimbly.
How is climate change figuring in to your personal retirement plan? Weigh-in using the comment form.