A long-time reader passed along an article from the World Economic Forum’s blog (yes, for some reason the World Economic Forum has a blog) titled “To retire at 65, American millennials need to save almost half their paycheck.” While the article is absolute drivel, it’s a good starting point to understand some things the business and financial press gets consistently wrong about savings.
The article itself makes no sense
The extremely thin premise of the article is easily dispatched with: relatively high stock market prices today suggest that future returns will be relatively low. That means projecting today’s return on savings forward means today’s workers will have to fund a relatively large portion of their retirement spending out of savings and a relatively small portion of their retirement spending out of dividends and price appreciation.
I will make a simple observation about this thesis: retirement savings are accumulated over time, not with lump-sum contributions. The idea that “high prices today predict low returns tomorrow” only applies to this year’s contributions. Next year’s contributions will earn returns based on next year’s prices, and contributions made 10 years from now will earn returns based on prices 10 years from now. In other words, assuming steady or rising contributions, today’s prices tell you nothing about the lifetime savings rate required to achieve a given level of income replacement in retirement.
To give a simple example, the 30-year Treasury bond rate reached a high of about 14.8% in 1981. Since $1 invested at 14.8% for 30 years yields $62.84, using the World Economic Forum’s logic, a 35-year-old in 1981 could have invested just 0.8% of their salary each year in order to replace 50% of their pre-retirement income, since 30 years later, that 0.8% would have swollen to 50%.
The problem is that 10 years later, the 30-year Treasury rate had fallen to below 8%, and the same 0.8% salary savings would replace just 8% of their salary 30 years later. The World Economic Forum is making the primitive mistake of projecting this year’s expected returns forward to all future years.
With the Social Security full retirement age already raised to 67 for my generation, even the oldest millennials have 25 or more earning years ahead of them; of course it’s possible today’s high stock market prices will continue for the next 25 years, but let’s just say I have my doubts. And if we do have 2, 3, or 4 crises, recessions, or depressions between now and then, there will be plenty of opportunities to buy assets with expected returns just as high as they are low today.
The financial press doesn’t get it: no one saves anything
In some ways it’s unfortunate that we use the same verb in two radically different, almost opposite meanings: to “save,” and to “save up for.” To “save up for” is the most common and natural thing in the world, and virtually everybody does it. Whether you’re saving up for Christmas presents, a new console game, a down payment on a house, or an anniversary dinner, the idea is the same: you set money aside every week or month, for a known or unknown period, and then you spend it, and it’s gone. This is not fundamentally different from buying something on credit, it’s just cheaper: with credit you get the object of your desire up front, then pay for it over time, while with savings you pay for it over time, then get it at the end.
But “to save,” let alone “to invest,” means something totally different. It means setting money aside, for an indefinite period of time and for no definite purpose. This behavior is vanishingly rare because upon a moment’s reflection, it makes almost no sense.
First, setting money aside today comes with an obvious cost: that money could be spent instead. It’s one thing to save up $300 for a new gaming console; it’s another thing entirely to have saved $300 and then, instead of buying a new gaming console, keep saving instead!
Second, the indefinite period creates obvious risks. I’m not talking about investment risks, since even most people who do save don’t invest their savings. I just mean the risks of doing anything over time. Maybe you’ll die before you ever spend any of your savings — you can’t take it with you. Maybe you’ll get divorced and “lose” half your savings to your former spouse. Maybe word will get around that you have savings and your friends and relatives will come around asking for a “loan.”
To put it as simply as possible, if saving were easy, the government wouldn’t have to go to outlandish lengths to encourage people to do it. And despite those outlandish efforts, the only people who save are still the same people who would do it anyway: high-income professionals. Don’t get me wrong, they’re happy to take the government handouts, but the handouts are pure gravy.
The fantasy of the retirement “number”
Let’s turn back to the underlying premise of the World Economic Forum post: the goal of retirement saving is to replace a certain percentage of your pre-retirement income by setting aside money during your working years. If you can project forward both your earnings trajectory and your investment returns (whether on a year-by-year basis or using the “starting year” fallacy described above), then you can determine the total balance you need to have in your accounts on the day you stop collecting a paycheck.
But who could this model possibly describe with any degree of accuracy? The majority of people start collecting Social Security old age benefits on the day they become eligible, and have no savings or an amount that is simply inconsequential to their long-time retirement spending needs. Using the 4% rule, someone who has managed to accumulate the fantastic sum of $100,000 at retirement can only safely withdraw $333 per month to supplement their Social Security benefits, and if the money is kept in a risk-free account, the safe withdrawal rate must by definition be even lower.
On the other hand, savvy high-income professionals pour vast sums into their pre-tax retirement accounts, 529 accounts, Roth accounts, HSA’s, after-tax 401(k) accounts, and these sums accumulate so quickly they dwarf any conceivable financial needs in retirement.
What the “retirement number” presupposes is that there’s some group of people in-between, who can afford to save more than nothing, but less than the absolute maxima allowed in tax-advantaged accounts. And this group no doubt exists: there are a lot of numbers between $0, the amount saved by most people, and $19,000, the amount contributed by high-income professionals to their 401(k) plans in 2019, so in a country of 350 million souls there are certainly people contributing $1,000 and people contributing $18,000.
Unfortunately, the first $1,000 you save does nothing for your retirement security (you’ll still rely on Social Security old age benefits), and the last $1,000 you save does nothing for your retirement security (you’ll retire wealthy no matter what).
Finance journalism is an ideological project
What all the above should make clear is that the relentless focus on this sliver of the population, the “in-betweeners,” is not about personal finance, it is about ideology. Tax-advantaged investment accounts obviously provide the overwhelming majority of their tax benefits to the people who can afford to contribute the most money to them, and no benefit at all to people who can’t afford to contribute anything.
If retirement income security, or affordable higher education, were really public policy goals, then the money currently spend shielding the investments of the wealthy from taxation would go a lot further in boosts to Social Security benefits and public subsidies for higher education.
But if you can create a mile-wide, inch-thick class of people who have contributed “something” to an IRA, 401(k), 403(b), or 529 plan, then you suddenly have tens of millions of people mobilized to protect those programs for the wealthy despite the trivial benefits they receive from them, and the ideological basis for cutting Social Security benefits and public higher education funding even further: anyone without sufficient retirement income should have raised their retirement contributions faster; anyone who can’t afford to send their kids to college should have opened that 529 plan earlier.
After all, the financial press was there all along telling you to, so you have no one but yourself to blame.