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.