William J. Bernstein
Retirement Calculator from Hell, Part IV:
A Nation of Wal-Mart Greeters
In the previous three pieces of this series (Part I, Part II, Part III), we discussed the grim mechanics of retirement planning. While a basic spreadsheet run shows that saving 10% or so of your income at an after-inflation return of 4% beginning at age twenty pencils out to twenty successful years of retirement after age sixty-five, the vicissitudes of the real world make this a chancy proposition. Retire in the wrong year and you’re in deep trouble very quickly. Start saving at a later age and things go to hell even faster: For every ten years that you delay, you approximately double the amount you need to save. If you start after age forty-five, it is virtually impossible to plan for a normal retirement.
Our national savings rate is truly dismal. As traditional defined-benefit retirement plans go the way of liberal democrats and disco, most workers are left with Social Security and 401(k) plans as their exclusive sources of retirement income. A recent survey of 401(k) participants shows that the median plan balance for employees nearing retirement (the sixty to sixty-four age group) was $25,000. Plug that into your financial calculator and smoke it!
Surely, then, the solution must be for workers to save more. Let’s say 100% of workers woke up tomorrow morning, smelled the coffee, ate their Wheaties, and began salting away 25% of their salaries into retirement savings. In very short order, this would do to corporate earnings and stock prices what Genghis Khan did to the steppes. The tradeoff between increased savings and the resultant depression in asset prices (from decreased consumer spending) is a mind-boggling macroeconomic calculation, but a fast look at Japan, with its high savings rate, is not encouraging.
There’s a simpler way to examine things. I am grateful here to Thornton Parker, who first raised the issue in What if the Boomers Can’t Retire, and, more recently, to Robert Arnott and Anne Casscells, who kindly supplied me with their working paper on the topic. At base, what we have is x number of workers supporting y number of retirees with goods and services. The retirees may be paying the workers with saved dollar bills, stock certificates, or Krugerrands, but at the end of the day, the method of savings/payment is irrelevant. As the number of retirees increases, the goods and services produced by the remaining workers become thin on the ground. In this case, it does not matter how much retirees have saved—the value of their dollar bills, stock certificates, and Krugerrands will fall to the point where the workers are finally willing to take them in exchange for those goods and services.
The world’s first government-sponsored retirement system was Bismarck’s, begun in Germany in 1883. The Iron Chancellor, wishing to co-opt the Socialists, decided on sixty-five as the retirement age, and we have been stuck with it ever since. In an age without adequate nutrition, antibiotics, high blood pressure medicine, and rudimentary occupational safety, only a few percent made it past the finish line, and those that did survived only a few years. Even when Franklin Roosevelt signed the Social Security Act in 1935, relatively few lived to qualify—in that year, there were forty workers for every beneficiary.
How things have changed. Today, the median life expectancy for men is seventy-five years; it’s eighty for women. Currently, there are three workers for every retiree; by 2050, there will be only 1.5 workers supporting each retiree.
Imagine, if you will, a desert island on which there are only five inhabitants—four workers and one older retired person. Each of the four workers does several odd jobs: growing various foodstuffs, building shelter, providing rudimentary medical care, and the like. The medium of exchange is coconuts. Every month, each of the four workers gives a few of his coconuts to the retiree.
One day, one of the remaining four workers turns sixty-five and decides that he, too, wishes to retire. If he does so, instead of each worker supporting 0.25 retirees, each would be supporting 0.67 retirees. Not only that, but the total GDP of the island would fall by 25%; so would per capita GDP. What do you suppose the response of the remaining three workers will be to an apparently healthy-looking colleague who demands that they support his idleness?
Let us further assume that the candidate-retiree has planned for his nonproductive years by accumulating a disproportionate number of the coconuts. In doing so, he has done nothing to increase the productivity of the island. Now that he must spend the coconuts, the island will find an increased number of them chasing 25% less goods and services. The result is a predictable bear market in coconuts and dramatically more expensive goods and services.
Worse yet, to the extent that he has planned ahead and saved, he sows social discord, for even if he himself has accumulated enough coconuts to counteract the effects of higher prices, he has raised prices for everyone else in the process.
This example was not arbitrarily chosen. The 4:1 and 3:2 ratio of workers to retirees is about what was the case in 1990 and what will be the case in 2050, respectively.
In an era when a small number of people lived past sixty-five, society could easily support them for the very few years they survived beyond that point. Now that citizens are routinely living two decades longer, it is simply not mathematically possible, let alone politically feasible, to expect each worker to support 0.67 retirees, no matter how many coconuts, dollar bills, stock certificates, or Krugerrands they save up in the meantime. It is also not reasonable to expect productive younger individuals to support large numbers of healthy older non-workers.
As Arnott and Casscells succinctly conclude, what we have is not a savings crisis, but rather a demographic crisis. We will not be rescued by increased voluntary or enforced savings. The idea of investing Social Security funds in stocks, so fondly embraced by right-wing think tanks, is a prescription for capital-market instability. (The most salient feature of the American Enterprise and Heritage Institutes is just how little thinking actually goes on inside them.)
The solution, then, is for folks to retire later. We’ve already started down that road by raising the retirement age for future retirees to sixty-seven. Unfortunately, we have a ways to go. In order to keep the current worker-to-retiree ratio at 3:1, Arnott and Casscells estimate that the retirement age will gradually have to be raised to seventy-three. Of course, the government need take no action; politically, it will prove far simpler to let poor asset-class returns and low savings force older Americans to postpone their retirements. In the past few years, millions rudely awakened to the fact that they weren’t going to retire at forty. Over the next few decades, most of the remainder will discover they won’t be doing so at sixty-five, either.
That’s the bad news. The good news is that this analysis pertains only to society at large; if you’re reading this article, you are likely saving more than average. To the extent that you do, you’ll be able to retire that much earlier than seventy-three. The really good news is that your cohorts are saving so pitifully little that this will be relatively easy to do.
The above applies only to the Boomers. The X-ers, and those coming after, will have a much harder time of it. If you are currently under forty, you will shortly be traumatized by the sight of large numbers of your parents’ generation subsisting on cat food, and your generation will begin to save prodigiously. In such an environment, it will be very difficult to gain a comparative advantage over your peers.
If you want to retire early, what matters is not how much you save, but how much more than everyone else you save. In a world where everyone saves as if they’re going to retire at fifty-five, or even at sixty-five, none can.
Copyright © 2003, William J. Bernstein. All rights reserved.
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The right to download, store and/or output any material on this Web site is granted for viewing use only. Material may not be reproduced in any form without the express written permission of William J. Bernstein. Reproduction or editing by any means, mechanical or electronic, in whole or in part, without the express written permission of William J. Bernstein is strictly prohibited. Please read the disclaimer.