Thursday, October 13, 2011

The Financial Realities of Individual Retirement

I am writing this for several reasons but one important one is to further establish the importance of paying attention to the real world when attempting to make policy recommendations like some recent suggestions as to how to deal with the entitlement mess.

To begin, let’s review the current situation:

1. The current ideal is to retire at age 65 and live in blissful non-productivity for 20 to 30 years.

2. Up until the 90s, it was expected that a worker would accumulate pensions from his employers over the years and when he retired he would receive a fixed income to support him. These pensions have been disappearing steadily for decades and there only a few left for new hires. The health of company savings to support existing pensions is in question. There is a federal agency that would supposedly put funds into a failing pension fund, but it is underfunded itself and could not rescue an economy wide problem (such an agency shouldn’t exist, either). (For example, see)

3. Self-funded retirement plans, such as the 401(k), have been shown by repeated surveys to be insufficiently funded by employees to provide for their retirement. The gap is very large. Employees also have the tendency to remove the funds from retirement accounts at various times for various reasons.

4. Survey after survey has documented that Americans have a very poor grasp of how to manage their savings and investment, including retirement accounts. The primary element driving most decisions is fear of loss. The sources of their fear are stories about the Great Depression, reading newspaper headlines, incomprehensible discussions of investment options, stories of thief and greed, and the economic chaos around them.

5. Retirees are becoming increasingly dependent upon Social Security and Medicare after retirement (see below).

6. The government dominated economy has resulted in two major recessions in the last ten years resulting in the current period that is described by the government and press as a recovery but feels very much like a bad, senseless downward spiral.

Consider the situation of a reasonable, hardworking, educated baby-boomer who has been successful from the standpoint of the quality of jobs and his level of income. Let’s call him Max. Max is 62 and all his life he has accepted the idea that age 65 he will retire. As a responsible person, he has saved and tried to make sound investments his entire life. He has not hired professional help other than talking to various stockbrokers. He began working as adult in 1972 but didn’t begin paying attention to the issue of savings for several years. His initial experience in the 70s was with high inflation and then the recession that ended in 1982.

But Max has now entered what will surely be remembered as the golden years of investing for the baby-boomers. From 1982 until December 1999, the market rose nearly continuously (for example, 1987, which is remembered as the year of a crash, was actually up slightly for the calendar year.) The later 90s were somewhat skewed by the inflation fueled tech boom, but overall, the period was the best of the Twentieth Century.

Since 1999, the investment markets have flattened or worse. Consider that the inflated high of the Dow Jones Industrial Average of December 1999 was 11497. As I write the Dow is 11471 (and in my opinion, it is over priced). After nearly twelve years, the Dow sits at the same place, nominally. I say nominally because the dollar today is not the dollar of 1999. If we accept the government Consumer Price Index as a real measure of consumer prices over time (I am not advocating using the CPI, but I don’t know of a good alternative.), since 1999 the dollar has fallen over two percent a year. According to the Department of Labor’s online inflation calculator, it takes $1.36 today to buy the same stuff as one dollar in 1999, or today’s dollar is worth $0.73. (The same calculator gives the today’s figure of $234.76 in relation to 1982.) That means that if you correct for inflation today’s Dow is 73% of what it was, or 8434, not 11471. Even if you add in dividends and subtract taxes (capital gains taxes as well), you have a result that a general investment in American productive assets for the last twelve years has been a very large loss. Max has suffered a major blow to the prospect of a comfortable retirement. Maybe Max may not be able to retire at all, even with Social Security, although I am not sure that there would a job for Max when he needs it.

How could Americans prepare for retirement in such an economy?

Most prescriptions offered for investing for retirement assume an economy that is growing. Those recommendations didn’t work in the decade ending in 1982 and they aren’t working now. There are recommendations for periods of crashes and depressions. If these ideas work at all, they generally don’t work for prolonged periods of time. There are other approaches that do work to a certain extent and are good. However, they tend to be complex and assume knowledge that few have. They also wouldn’t work if widely practiced (which is to say that I am here concerned with the general situation and not how an individual could protect himself). For the vast majority of people, there is no good investment option today that will help them through to their last years.

Another little known fact is that those people who have saved some assets for retirement have often not actually planned. Their accumulation was based on what they could save and invested in what made sense at the time. Many, when they retired, accepted the conventional wisdom that retirement income needed to be “income without undue risk” and placed significant amounts in bonds. These people will tend to run out of money even faster during retirement. They don’t have enough to support their rate of spending for very long. Nor do they or their advisors have the tools to recognize the threat and make changes early enough to make a difference. They have not made provision for consumer price inflation or the rapidly rising cost of medical care. They aren’t prepared for 20 years or more of idleness. They just don’t know how to plan financially and don’t know they should.

For the many people who keep whatever they have managed to save in “safety of principle” accounts (fixed annuities, savings accounts and CDs) or fixed income accounts (bonds and pensions), they have seen their assets and income slowly decline as the Fed has kept interest rates low, inflation continues, and the what small income they receive is taxed. People with bonds have seen their principle increase as interest rates and their income have declined. But, if they are paying attention, they know that the future probably holds higher interest rates (see Greece, Spain, and Italy today), and their principle will drop like a rock if they still hold those bonds.

Beyond that it should not be surprising that very few people have any idea of how to invest. They do not know how the economy works. Where would they get that knowledge? It isn’t taught in schools at any level nor do the academics actually know anything about the real economy. They don’t know how retail businesses work. They don’t know how manufacturing works. They don’t know how businesses make profits. They don’t know how international commodity or currency markets work. They really don’t know why stocks have the prices they have or why they change, short term or long term. The ignorance about economics or our economy is more than widespread. It is terminal. Who suggests that it is important to know? People learn about their own professions, but often not much beyond that. Business schools are not good sources, either. Most businesses have to retrain business school grads, even MBAs. It is no wonder that few people are able to save and invest in a manner that will successfully support them into their 90s, especially if they retire later than normal. The number of people who do adequately save and invest has to be less than five percent.

A realistic look at today’s economy would suggest that the foreseeable future does not hold the promise of better results. There is no indication that anyone in authority has a clue as to what makes an economy grow and contract. They do not even understand that only productive, profitable jobs are worth creating. Government debt will continue to pile up. The Fed will continue to add stimulus, achieving nothing but a huge financial overhang that may fall and crush us. Don’t forget that the regulations required by all of the reform bills after the Meltdown in 2007-8 have yet to be released and implemented.

It seems to me that any criticism of people for not being prepared for retirement is not based upon a recognition of the facts of the real economy. Only a very few are going to have found a method to invest their savings in such a way to be able to support themselves if they retire.

To sum up, it is very difficult for salaried or wage paid individuals to save and invest successfully for their retirement, standard pension plans have suffered significantly due to the economic conditions, and from other sources we know that Social Security and Medicare can not continue for very long. So, what can we conclude? My conclusion is that the mixed economy, the welfare state in the United States, cannot support the coming old age of the baby boomers, with or without Social Security.

These problems that people have with their savings and investment, the nature of our economic situation, and the poor future prospects are not the fault or the responsibility of individuals. The responsibility lies with the people who control the dominate actor in our economy, the Federal government in its many aspects: the President, the Congress, the Fed (and the intellectual leaders who guided them).

What else did you expect from 100 years of constant legislative attacks on capitalism and the businesses in the United States. That the problem has not been big until now is a testament to American perseverance. It couldn’t last forever.

For the future to achieve the promise of a happy old age, not to mention prosperity for everyone, in the US, a couple things have to happen:

1. The economy has to be freed up to become productive and prosperous. In other words, our country needs to become a capitalist nation. The process of transforming ourselves from a welfare state to a nation that recognizes right must do so in a manner that does not further victimize the present day population, as I discuss elsewhere.

2. People need to revise their thinking about retirement and work. Work is not the onerous thing most people make of it. Retirement for 20 or 30 years, after working for 40, is not generally feasible in good situations, let alone the one we are in today.

This Post is one of three that deal with the issues connected with the entitlement mess and how to resolve it. All three should be read in order to fully understand the issues. The other two Posts are:

A Flight of Fancy (Not Fantasy)

The Right Way to Solve the Entitlement Problem

Thank you.



  1. Not their fault? These people want me and other young people to work our hands to the bone so they can drive around in their RV and own a house outright! While young people have no assets and student loans?

    I'm not staying in the US--I'm already in Asia where work is appreciated. Screw the old voters. They can inflate their currency to pay for the entitlements which they always vote to protect. I'm not going to pay.

    The old people are the most entitled welfare leeches in the US. The majority of the US welfare state *is not* for the poor, it is for the middle class retirees who want to have a 25 year vacation. All of the unfunded liabilities are for *them* and even the fogies in the Tea Party don't want to touch medicare.

  2. Thank you for your comment, Anonymous. I hope that you didn’t miss the actual point in the post, which wasn’t the mistakes of the generation. By saying that it isn’t their fault I merely meant that if the economists weren’t willing to see the consequences, you can’t expect the man in the street to see it. They certainly voted for it and they are certainly going to experience the consequences as well. (I am writing a series of posts about the situation, for example see the post before this on Entitlements.) Their primary motivation today is fear, as is yours, apparently. But, Anonymous, don’t become collectivist in your thinking. There are only individuals. There is no collective “old people” with all the same attributes.

    But your solution may not be as good as you think it is. Japan is in worse shape than the US. China, because of its one child rule, will face the same results as Europe and the US. I do not know the situation in every country and you didn’t say which one. It is unlikely that you will be able to avoid the problems that the others are facing. You see the leaders and bankers nearly everywhere all went to the same schools and read the same books that the leaders and bankers did in the US, Europe, and Japan. You can see the Chinese trying to emulate the Western governments (plus be totalitarian Communists, too). For your own protection you need to check the demographics and the “social programs” in the country you are in.

  3. Shouldn't the word be "principal" and not "principle"?

  4. Observer, you are right. Thank you for pointing that out. Your observation shows the value of having good proof-reading, as opposed to basical no proof-reading. That is a problem with most blogs that I see, and mine, too. Good editing is good writing.

  5. Glad to help.....thanks for writing these...