My associates and I, like most financial planners, worry about people outliving their money – and the fact our firm works mainly with people who are quite well-off relieves only some of our concern, not all of it.
Sure, we run our long-term projections under multiple scenarios, including assumptions of adverse long-term market returns, which are unlikely to actually happen if history is any guide. We allow for the guesswork involved in estimating spending patterns many years into the future. We know where inflation stands today and what it is likely to do in the near future, though the margin for error gets much larger as we look further ahead. Still, these factors are not what I worry about the most.
To me, the most troublesome variable is the assumption about how long someone will live. If you’re consuming capital (except for the wealthiest retirees, almost all retirement funding requires consuming capital rather than living solely on the return it generates), then the exercise boils down to the question of how long it will take until all the available capital is spent. The longer the life span for which you are planning, the longer you need to try to stretch the available resources.
But how long is that?
We know that the average 65-year-old American will live into his or her 80s. We know that a large fraction of those people will live past 90. We can look at tables that tell us how many years, on average, to expect someone to live beyond age 50, or 40, or 25, or even from birth. Averages are fine for pension funds and insurance companies, which can plan for large groups of people, but individuals must consider how far from the averages they may eventually depart. My aunt, born in Hungary in 1916, should have died long ago, according to the averages. But she’s hale and happy at age 95, and there is no telling how long she will be with us. That’s wonderful for her and her family, but a challenge for her financial planner, meaning me. (Don’t worry; I’m on top of her situation and she’ll be fine.)
What should we assume about future medical progress? How long will today’s baby boomers, who currently range from their late 40s to mid 60s, be with us? How long will their kids be around? How healthy and active will they be? How much will they earn, and for how many years? What will it cost today’s young people to take care of those boomers?
Social Security merely transfers cash from people who are working today to people who are not. The current administration’s short-term finagling with the Social Security employee tax rate, cutting it by 2 percentage points in 2011 and 2012 without any corresponding reduction in the program’s obligations, has made transparent what has always been true: Nobody funds his or her own retirement through Social Security. The program need not go away, but eventually the benefits Social Security provides will have to be balanced against the resources that working-age people are willing to devote to it. With more retirees and fewer workers, the future will inevitably be less generous to Social Security recipients than the past or present.
Pension plans are another collectivized form of retirement savings, but they face the same demographic challenges as Social Security, and some of the same funding problems, though to a lesser extent. By and large, the more generous the pension (public employee plans are notably more generous than private plans nowadays), the less likely it is that all of the promises and expectations will be met. The private sector’s decades-long movement away from pensions and toward individual savings-type plans like 401(k) arrangements is derided as more risky for the employee. I don’t agree. The same risks exist in collectivized and individual plans. At least in the individual plan, the individual can manage such risks proactively.
People used to save for their own retirement, and by the time they stopped working, they planned to put most of their savings into income-generating investments like bonds, certificates of deposit, and rental properties. Right now, however, our monetary authorities are waging war against savers, with rock-bottom interest rates that are negative after taxes and inflation.
Another traditional retirement haven is U.S. Treasury obligations. Unlike Greece, which defaulted because it could not pay most of what it owed on its euro-denominated bonds, our government can just create the money it needs to repay Treasuries, though doing so would trigger substantial inflation. It is a desperate measure that the Federal Reserve swears it would never take, but if the choice is between high inflation and the financial Armageddon of U.S. default, the Fed will absolutely opt for inflation. For now, the Fed is managing to float the government’s massive debt with ultra-low interest rates.
The federal budget is now a hostage to those low rates. With the accumulated debt already near $15 trillion, each percentage point of higher average rates would cost an extra $150 billion per year. Eventually, when demand for Treasuries dries up and the Fed is no longer able to keep rates low except by financing the government itself, we will be looking at a very bleak picture.
There is a way out. Remember, the root of the problem is that people are likely to live for many years after they stop generating income from their labour. But we don’t have to generate income only from labour; capital can generate income too. That’s why people lend money – or at least it was why people lent money, before the federal government began crowding out all sorts of other borrowing and required ultra-low interest rates to do it. For the foreseeable future, savers and lenders are not likely to get a fair return on their capital.
But businesses generate income, and they are quite capable, and increasingly willing, to dispense a fair portion of that income to shareholders. If we change the way we think about financial security and financial risk, and if we establish government policies that encourage more individuals to own well-diversified corporate shares and more of those corporations to pay dividends, we can provide a substantial source of income that can last indefinitely.
Let’s leave it here for today. I’ll pick up this thread in tomorrow’s commentary, in light of Apple’s recent decision to pay its first dividend in 15 years.