It's All About Risk
While reading the Sunday Des Moines Register last weekend, there was an editorial that caught my eye: “Allow Us To Chart Our Own Future”.
In the editorial, Tim Albrecht, a young staff worker in the Iowa
Legislature discusses his desire for personal accounts, but begins his
argument with this question:
[But] How do we ensure that ours and future generations remain secure in retirement?
The analysis that follows is confusing at best, dangerous at worst.
I will make a statement here that many seniors (and money managers), looking at experience will probably agree with: Your Social Security contribution is not enough to provide you with a comfortable retirement.
There
needs to be more than just a contribution of “12% of your paycheck” to
secure your retirement. Retirement savings have been described by
others as being a “three-legged stool”, each leg having its own risks
and rewards.
Personal Savings and Assets
Savings
and Assets is what you spend a lifetime working for. In the case
of most people, the main “asset” will be a house that you have finally
paid off by the time you retire. There might also be savings
accounts, mutual funds, stock purchases – or even the cash you keep
under your mattress.
What's
been happening in modern times? Personal savings have been
suffering. Housing costs have escalated, putting more “personal
savings” money into paying off interest on larger home mortgages.
Consumer debt is at all time highs.
Employer Provided Pensions
This
part has been flucuating for the past 20-30 years. My generation
(35 and under) are unlikely to ever see a “pension” the way our
grandfathers did. In their place is the ubiquitous 401(k) plan –
often matched with either cash, or oftentimes company stock.
Pensions
have seen the largest shift in risk management – 401(k) plans remove
the risk of a company providing a “defined benefit” sometime in the
future, to a “defined contribution” now. With the defined benefit
pension, managers of pension funds had to manage contributions to the
fund to insure that their investments returned a profit to the fund
over the long haul. If not, then the company had to fill in the
money needed to provide pensions with revenue from their business
operations.
With
401(k) plans, employers no longer have to manage that type of
risk. Instead, the employer contribues a benefit now to an
individual account – so the company will never have to worry about
“filling in” shortfalls. The employee instead has to worry about
that 401(k) portfolio – and about making that last for the duration of
their retired years.
More
nefarious: the company 'contribution' being in the form of
company stock. If the company falters (there have been many
examples lately), the company owes nothing to their employees, who now
hold a worthless retirement portfolio.
Social Security
This is
the one part that is the most stable “investment” we make. Social
Security is the one leg on the stool that has been constant through
every boom and depression since 1940 or so. Social Security will
likely not allow you to have the “luxurious retirement” one usually
hopes for – it might be enough to help you manage the smaller costs of
home ownership (or cheap rental) and buy groceries.
As it
stands today, Social Security pensions are the buffer that can keep you
out of poverty when everything else fails, and you cannot work to
support yourself.
Who Takes The Risk?
So far,
we've seen that the risks involved with retirement savings have been
dropping for institutions, like employers – and rising for individuals,
who have to shoulder those risks alone.
Now,
when we talk about pushing the risk of managing a “Social Security”
portfolio away from a large group – like the Social Security
Administration – and on to individual citizens, suddenly the individual
is taking on all of the risk involved in saving for retirement.
Business
publications talk constantly about minimizing risk – because company
profits (and stock prices) depend on the choices you make. It's
far better in the eyes of a business to force “the industry” to take on
a risk (for example, semiconductor manufacturers funding research
together) or to push risk onto “the government” (agriculture, airlines).
The same
principle should apply to individuals – we're more likely to succeed if
risk is externalized. Traditional retirement planning splits risk
between individuals, their employers, and the government. Over
the past 30 years, employers have removed themselves from the equation,
leaving individuals to manage growing risks – with Social Security
being the safety net. Phasing-out Social Security will take away
that safety net altogether, which balances our “stool” entirely on one
leg: individual investments and savings.
The
stakes here are high: if an individual “succeeds”, they will
enjoy a safe and secure retirement. If they “fail”, we will
return to the situation where the elderly relied on their children, or
on public and private welfare systems – which was the situation before
the New Deal stepped in to provide individuals the tools to manage the
risks of saving for retirement.
So, back to the original question:
How do we ensure that ours and future generations remain secure in retirement? The
only way we ensure security is the way business ensure security:
risk management. Phasing out Social Security will remove
our ability to externalize risk – leaving us with only the option to
place all of our trust in the markets, like Americans did before 1929.
A
cursory glance at history tells us that trusting the markets
whole-heartedly is the largest “faith-based initiative” we could take
on.
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