2009 October 12 Monday
The Retirement Underfunding Debacle Is Approaching
Time Magazine complains about how people do not have enough money in their 401(k) accounts to retire. The problem here is that people do not want to save. They want to spend now. Time is basically saying that humans can't be trusted to save for their own future. That's certainly true of a large fraction of the populace. But what to do about it if anything?
The ugly truth, though, is that the 401(k) is a lousy idea, a financial flop, a rotten repository for our retirement reserves. In the past two years, that has become all too clear. From the end of 2007 to the end of March 2009, the average 401(k) balance fell 31%, according to Fidelity. The accounts have rebounded, along with the rest of the market, but that's little help for those who retired — or were forced to — during the recession. In a system in which one year's gains build on the next, the disaster of 2008 will dent retirement savings long after the recession ends.
My reaction can be summed up with "as compared to what?". The money in 401k's is not enough. Okay, fine, The biggest alternative one can point to is pension funds for government employees. Those government employee pension funds are a disaster waiting to happen. Politicians over-promised and under-funded.
Before the crisis, many public pension funds had experimented with risky trading techniques or committed more of their money to hedge funds and other nontraditional firms, which in turn invested some of it in complex mortgage securities. When these melted down, pension funds got burned.
Now, facing an even bigger funding gap, some systems are investing in the same securities, betting that a rebound in their value will generate huge returns.
"The amount that needs to be made up is enormous," said Peter Austin, executive director of BNY Mellon Pension Services. "Frankly, they are forced to continue their allocation in these high-return asset classes because that's their only hope."
People can't be trusted to save for themselves. But governments can't be trusted to save for you. Okay, got a third idea in mind? Corporate pensions could make a come-back. But corps would need an incentive for bringing them back: prospective employees of corps would need to assign a bigger weighting to the pension plan when choosing a job. Good luck with that one.
People are going to need to work longer and save more. Increase your pension fund contributions. If you are an American then open an IRA or similar account if you do not already have one and set up automatic deposits into it.
Even under unrealistic optimistic assumptions the state of Virginia's major pension funds are grossly underfunded. No way are public pension funds an example to follow.
But Virginia officials now estimate the funding level of its major pension funds will sink to about 60 percent by 2013.
From there, the deficit will grow even wider, according to Kim Nicholl, the national director of PricewaterhouseCoopers public sector retirement practice. Even if public pension funds were to hit their 8 percent investment targets every year, Nicholl calculated they would have less than half of what they need by 2025. This is because a greater share of the population will be retired and those who are will live longer, thus collecting benefits longer, she said.
Hey, big government pension funds have professional managers. But they still lost big when the market went down. Also, legislatures do not fund the pension programs well enough. What to do? Cut benefits. Make people work longer. These measures are coming. Do not plan on retiring whenever your current pension planning makes you think you can retire.
I think the real picture is far worse than the above describes. The assumption is that the economy will grow and increase the value of stocks. But what happens if Peak Oil makes the economy shrink? The holes in pension plans then become massive. I expect that to happen. My advice: Live on less, work harder, save more, work longer. Find ways to earn extra income.
All pension schemes are pyramid schemes. The baby boom generation was very large and very productive. The workforce actually grew faster than the population because women entered the workforce in far greater numbers. The boomers' parents could retire on pensions because they didn't live as long and there were far more boomers than parents. The boomers did not produce a huge crop of kids that was far more productive, so now there are not enough buyers for the stocks they stored their money in. The stocks are worth less because they were already over priced due to demand as an investment vehicle and the companies' customer base is not expanding rapidly like it was before. If immigrants were graduating high school and becoming as productive as boomers, they could be a resource. Unfortunately, they are not, and it appears they cannot. Instead they are a net loss because they earn and produce at third world levels and consume more social services than they pay in taxes.
Basically it doesn't matter how much you save if there are not enough people providing the goods and services you need. The price will increase to reduce the demand.
Health care is a good example. Many great doctors are boomers who will retire with the rest of the boomers. Rather than skilled doctors going up with demand, they will be going down as demand goes up. The older, US trained, highly skilled doctors will be in shortest supply and younger foreign doctors will likely be increasing.
The problem with making people work longer is that the marginal utility of labor declines when there is more labor because of immigrants, or people working longer. People working longer increases the supply of labor, and reduces the marginal return on labor.
The suggestion of people working harder is a bad one, since a poor work ethic is not the cause of this crisis.
Read this report for a discussion of savings and investment:
If you want to increase national savings, you need to have something to actually invest in. So what should the nation (or world) invest in for retirement?
Just a quick review:
Y = C + I + G + (X-M)
S = Y - G - C
S = I + (X-M)
So where would a higher "I" come from or even a positive trade balance?
This is also one reason why I do not expect Treasuries yields to rise significantly in the long run (10 years). There are very few other investment opportunities out there assuming as the private savings rate will rise to fund government consumption because the private sector does not have any other investment opportuntities. A global economy crisis is actually beneficial to US debt since it reduces the attractiveness of investments.
It would help a lot if we had a system of taxation that rewarded rather than punished saving, work and investment. We should turn to a consumption-based system of taxation so that people who worked harder to earn more, save more and invest more would not get slammed by the tax system for their efforts
When there are people, like one of Time's profiles, who say they can't afford to live on 75k a year I think one of the answers is that Americans should have more modest expectations of their lifestyle in retirement.
I think it should be more accepted that people can take a lower paying job when they get older. Most people get less productive before they turn 65.
Also, Invest in real assets like precious metals and realestate. I think there is a very good chance inflation will be a problem at some point, potentially a huge problem.
Owning real assets also takes power from the banking industry (i.e. elites), an added bonus.
You are right to point to the problem of how to actually save. What to buy now that will generate wealth later? The answer is not obvious. Though I do have some ideas on how people can save for their old age:
1) Spend now in ways that cut costs in your old age.
A) Build or upgrade house that lasts a long time. You can put in a 50 year roof, long-lasting floors, and other house parts that cost more now but won't require repair in your old age.
B) Build or upgrade a house to be more energy efficient. A ground sink heat pump costs more today but lowers your utility bills in your old age.
C) Buy clothes that last a long time. I'm trying to shift toward longer lasting things like some pretty comfortable synthetic socks that Gold Toe makes.
2) Invest in commodities stocks. Preferably in companies whose reserves will last many decades. Chinese demand will keep up prices for some time to come.
3) Invest abroad to avoid the decline of the US dollar. Parenthetically, I would like to know some good Australian stock choices.
I am reading that Clarium Capital article. Thanks for bringing it to my attention. I commend it to anyone else reading this.
They talk about Japan's excess savings: Japan has missed a big opportunity to use all that savings to invest in energy generation methods that could cut and even eliminate the need to import energy. Japan could build enough nuclear reactors to power tens of millions of electric cars. Japan could build the electric cars. Japan could shift to ground sink heat pumps for cooling and heating. Japan's government ran up a huge debt far greater than the cost of doing all these things.
Japan then could have build massive multi-story hot houses and used nuclear reactors to power domestic automated factory agriculture and thereby ended its need to import food too.
There are ways to save. One just has to be creative about it.
Be careful what you ask for. We will only get a value added tax (VAT) on top of an income tax.
"People can't be trusted to save for themselves. But governments can't be trusted to save for you. Okay, got a third idea in mind?"
The whole problem is the basis of our monetary system. A fiat currency is naturally inflationary (people even tout that as it's main benefit) but because most people are more productive from 30-50 years old they need to then take a pile of cash and turn it into future assets (since inflation eats away at the principal otherwise). The result? An entire industry that chases returns to duplicate the effects of a currency that gains value rather than losing value over time.
Oh, plus that industry creates boom and bust debt cycles that crash the economy every now and again.
Third idea? Switch the monetary base to gold.