Tuesday, July 24, 2012

Planning For Retirement in an Era of Financial Repression

An article which appeared in last Sunday's New York Times Opinion section titled "Our Ridiculous Approach to Retirement" was very interesting, albeit depressing, reading. 

Here's an excerpt:

Seventy-five percent of Americans nearing retirement age in 2010 had less than $30,000 in their retirement accounts. The specter of downward mobility in retirement is a looming reality for both middle- and higher-income workers. Almost half of middle-class workers, 49 percent, will be poor or near poor in retirement, living on a food budget of about $5 a day. 

http://www.nytimes.com/2012/07/22/opinion/sunday/our-ridiculous-approach-to-retirement.html?src=me&ref=general

The article goes on to suggest that the best solution for most workers in the United States would be to have the government offer a plan that looks very much like a private pension plan:

...The coming retirement income security crisis is a shared problem; it is not caused by a set of isolated individual behaviors. My plan calls for a way out that would create guaranteed retirement accounts on top of Social Security. These accounts would be required, professionally managed, come with a guaranteed rate of return and pay out annuities. This is a sensible way to get people to prepare for the future. You don’t like mandates? Get real. Just as a voluntary Social Security system would have been a disaster, a voluntary retirement account plan is a disaster. 

However, while this might make intellectual sense, my guess is that today's political environment is just too toxic for such a plan to be implemented.

Which means most workers are on their own.

In my experience, many individuals tend to either play it too conservatively (e.g., low yielding bond funds) or "swing for the fences" (e.g., buy highly volatile stocks that offer only the remotest chance of a making a killing) when it comes to retirement planning.

Taking a balanced approach to saving to retirement should produce satisfactory results but also requires patience and a long-term time horizon - traits that are difficult for most of us to master.

In today's market, with interest rates at record lows, it would seem to make sense for retirement accounts to have the majority of their assets in equities.  However, this has not been the case.

Individuals have been fleeing domestic stock funds over the past five years in favor of bonds.  Unless you are very near the point of your life when you will need to start pulling funds out of your retirement account for living expenses, commons stocks should be the main focus of your investing activities.

This is not wild-eyed bullishness, by the way.  Instead, it is based on history going back to 1900, as Jeff Sommer's column in the Times Business section pointed out.

Sommer discussed a recent research piece published by Seth Masters of Bernstein Wealth Management titled "The Case for the 20,000 Dow".  Here's a couple of excerpts:

Over 10-year periods since 1900, stocks have outperformed bonds 75 percent of the time, according to Bernstein’s calculations. But today, bond prices are relatively high — their yields, which move in the opposite direction, are extraordinarily low — and stock prices are relatively low. So the firm sees the chance of stocks beating bonds over the next 10 years at 88 percent.

So is Mr. Masters simply making ridiculous return assumptions?  It didn't sound that way to me:

Precisely because bonds are now extraordinarily overvalued and stocks are undervalued, in his view, stocks are extremely likely to outperform bonds over the next decade or two. The Dow Jones industrial average is likely to reach 20,000 during that time — and probably within the next five to 10 years, he said. 

“Our projected stock returns may sound optimistic,” he writes. “They’re not. They are well below the long-term average for U.S. and global equities and based on conservative assumptions about economic and market conditions. Bonds, on the other hand, are unlikely to outpace inflation, because current yields are extremely low.”