Demography is Destiny, Hold On To Your Wallet
Already, the media drumbeat about “America’s retirement crisis” — laying further groundwork for a mandatory savings plan — is becoming deafening. You can barely swing a cat without running into a headline like, “Retirement Shortfall May Top $14 Trillion.” That was in U.S. News & World Report in June.
“Just 40% of Americans who worked in 2011 participated in an employer’s retirement plan,” says a recent BusinessWeek article, citing figures from the Employee Benefit Research Institute.
“The average working household has virtually no retirement savings,” says a recent report from the National Institute on Retirement Security. “When all households are included — not just households with retirement accounts — the median retirement account balance is $3,000 for all working-age households and $12,000 for near-retirement households.”
Even much larger nest eggs aren’t enough. “A million dollars isn’t what it used to be,” says a June New York Times piece harking back to the 1953 movie How to Marry a Millionaire. Even by the government’s skewed inflation figures, you’d need $8.7 million today to have the same purchasing power as 60 years ago.
“Inflation isn’t the only thing that’s whittled down the $1 million,” the Gray Lady goes on. “The topsy-turvy world of today’s financial markets — particularly, the still-ultralow interest rates in the bond market — is upending what many people thought they understood about how to pay for life after work.”
“Most people haven’t saved nearly enough,” Boston College’s Alicia Munnell told the Times, “not even people who have put away $1 million.” Munnell, we hasten to add, is an enthusiastic supporter of forced retirement savings.
Ultralow interest rates — even after the spike this summer — have all but trashed the old rule of thumb about how you should build up a nest egg big enough to withdraw 4% of your savings each year, plus a little bit more to make up for inflation.
As you can see in the chart nearby, that doesn’t work very well if you’re in a 5-year CD earning 1.5%. Or 10-year Treasury notes earning 2.5%. (The average over the last 50 years has been 6.5%.)
Into this void the academics and fund managers have stepped with what you might call “the Australian Solution.” Fair warning: The politicians won’t be far behind.
“In Australia, Retirement Saving Done Right,” reads the headline in Bloomberg BusinessWeek from late May.
“The Australian system increasingly is being held up as a model for the U.S.” says Time’s Kadlec. “In Australia, employers must contribute 9% of pay (rising to 12% in 2020) to every full- or-part-time worker between the ages of 18-70. This makes the accounts a little like a traditional pension in that the employer is funding them. But the accounts are owned and managed by individuals, as with a 401(k).”
The “contributions” and the investment earnings on them are subject to a 15% tax — less than most workers pay in income tax. Withdrawals can be made tax-free after age 60.
The program is called “superannuation” or “super.” It’s been around since 1992. Today, its assets total $1.52 trillion, more than Australia’s entire economic output in a year.
“It’s also nearly as much as savings held by the major banks,” says our old friend Dan Denning from the Australian Daily Reckoning, “and in top four in the world in terms of retirement assets.”
We asked Dan what’s the most important thing you need to know about super if you’re still in the workforce.
“That it’s compulsory,” he said, at the risk of belaboring the obvious.
“Governments know they can’t pay for the retirement of the public through social security,” he went on to explain. “But by funneling the money directly from employers into the market, it puts the burden of saving/paying for retirement on the stock market.”
What’s more, “the funds management industry earns great fees for doing nothing and pumping money into the market. Nice work, if you can get it.” Those $1.52 trillion in assets generate a lot of fee income regardless of market performance.
But — as Dan made clear at the outset of our warning alarm this month — Australians are at the mercy of that market performance. As you can see nearby, Australia’s benchmark ASX 200 index has underperformed the S&P 500 during the last 10 years, with greater volatility.
Stick with an ASX 200 index fund and you’re in for some serious stomach-churning moments. But for many Australians, it’s worse: “In reality,” says Dan, “you have less choice… and are locked into the asset allocation decisions of really unimaginative fund managers who live right in the middle of the bell curve.”
That is, if you accept the default option for how your super money is handled, you’re stuck with actively managed mutual funds from the usual suspects (Vanguard and Fidelity both have a big Australian presence)… and you’ll likely underperform a plain-old index fund, while paying higher expenses. The default option for many of those funds is “vastly overweight small-cap growth,” Dan tells us. “Most of the ‘balanced’ funds are anything but.
“This could be because Australia has a growth bias in the structure of its market. It’s a resource country with lots of mining stocks. That’s inherently a growth story.” Which is fine — as long as commodities don’t hit a speed bump.
That never happens… Heh.
Near as we can tell, there are two saving graces to super when it comes to America.
The first is that if the Australian model is followed, you stand a fighting chance at having some flexibility in how these funds are invested.
About 28% of all super assets are in “self-managed super funds” or SMSFs. The number of people opting for “do it yourself” has surged 74% since 2004. It’s almost imperative, says Dan, based on what the fund companies will do if you leave it to them: “If you don’t actively manage you own super, you’re overexposed to stocks as an asset class and growth as a sector. That worked like a treat here up until 2007. It probably won’t work very well for a long time.”
The downside to SMSFs is the compliance requirements — trustees, an auditor, quarterly filings, etc. “It’s a costly experience if you don’t have high net worth,” Dan says. “But costs are coming down.”
The other plus we see is that the advent of super in the United States will put off the day when “401(k) confiscation” arrives.
We’ve been following this hot-button issue since May 2012. We do not share the “clean out your accounts now!” alarmism that you find in some of the Internet’s fever swamps. But we also don’t dismiss the possibility that one day the government will come along and force you to invest a portion of your tax-advantaged retirement funds in U.S. Treasuries… because no one else will buy them.
An Australian-style super plan would make that kind of dramatic step less urgent. “The Australian government loves super,” says Dan, “because it provides an easy source for funding bond purchases.” After all, a typical fund has a bond component in addition to stocks.
“There are plans afoot to make it easier for super funds to buy government bonds or infrastructure bonds,” Dan adds. “In other words, it’s just another honey pot to fund government borrowing.”
We won’t let our guard down on the 401(k) confiscation issue, but all the same, we find the Australian Solution comforting in its own awful way. Mandatory retirement savings are a terrible idea — even if you have a choice of how the funds are invested. But all else being equal, it’s a better idea than forcing you to convert some of your existing 401(k) account into U.S. Treasury debt.
Ed. Note: As we keep a watchful eye on the 401(k) confiscation issue, we are always on the lookout for alternative ways for you to grow your retirement savings. Readers of the free Daily Reckoning email edition were recently offered extremely limited access to a unique investment opportunity designed to build up any retirement portfolio in a mere 30 days. To start receiving exclusive offers just like this one, we encourage you to sign up for The Daily Reckoning email edition, for free, right here.