In light of recent news it may not be fashionable to talk about giving the federal government additional powers. However it is hard to look at the question of retirement savings in the US and not think there is a huge, multi-generational problem. In part you could argue that it is a function of financial illiteracy. One potential solution to the issue of financial illiteracy is to design savings products that are “..cheap, transparent, simple and free of the ill-effects of leverage.”
However that may not be enough. It may be the case that individuals, even if they avoid the worst traps of the personal finance industry, are simply unable to voluntarily save enough to provide for themselves a comfortable retirement. Helaine Olen in her book Pound Foolish: Exposing the Dark Side of the Personal Finance Industry notes how the shift from defined benefit to defined contribution programs has by and large been a disaster for the American saver.
An article by Jeff Sommer in the New York Times this weekend looks at the tough times retirees are going to have replacing their income. In part that has to do with the extraordinarily low interest rates one can garner these days. The other reason has to do with undersaving. From the article:
“The bottom line is that people at nearly all levels of the income distribution have undersaved,” Professor Wolff said. “Social Security is going to be a major, and maybe primary, source of income for people, even for some of those close to the top.”
There are some things an investor can do including ramping up the risk of their portfolio through increased equity holdings to try and generate higher returns. However the past decade or so has shown us that the stock market is not an ATM machine from which one can extract guaranteed returns. It may be the case that Americans need to recalibrate that expectations for retirement including working longer and delaying their Social Security payments.
The big picture question is whether we as a society can do anything to help future generations avoid the tough trade-offs the next few generations will face as reach the traditional retirement age? Larry Fink the head of investment management giant Blackrock ($BLK) has called for a mandatory savings to be a big part of a “comprehensive solution to retirement savings.”
Many analysts look to the Australian “superannuation” system that has since 1992 has changed the way Australians save for retirement. By forcing workers to put 9% of their pre-tax income into retirement accounts Australia has amassed $1.5 trillion in savings which is roughly 7 times more per worker than in the US. There are other ways of handling retirement savings as this article shows but it is hard to see how you can generate substantially higher savings rates without some form of mandatory component.
It would be great if individuals stepped their own savings but that habit is simply not there for many. Cliff Goldstein at Marketwatch notes how a mandatory savings program could help change attitudes and habits along the way:
When planning for retirement, one of the main questions you should always ask yourself is: “Am I saving enough?” The implementation of a mandatory savings system with automatic escalation could potentially take much of the mystery out of answering that question. By automatically setting employees up with good savings habits at the start of their careers, future generations would likely find themselves much better prepared for retirement success.
In an ideal world everyone would generate sufficient savings on their own to help fund their own retirement. However most of the data shows that Americans are simply unable to do this on their own. Nor is the current system of savings consisting of 401(k)s and IRAs doing the job either. The next few generations may now be facing increasingly difficult retirement scenarios. The question is whether instituting real changes now can help save future generations from a similar fate.
UPDATE: Meir Statman writing at the Financial Analysts Journal looks at the issue of mandatory retirement savings and comes out in favor and lays out six criteria that should be used in setting any such system.
Items mentioned above:
Modest encroachments on privacy. (The Reformed Broker)
The mirage that is financial literacy. (Abnormal Returns)
Pound Foolish: Exposing the Dark Side of the Personal Finance Industry by Helaine Olen.
Why many retirees could outlive a $1 million nest egg. (NYTimes)
Mandatory savings accounts are coming your way. (Time)
In Australia, retirement savings done right. (Businessweek)
How they do it elsewhere. (NYTimes)
Should retirement savings be mandatory? (Marketwatch)