I suppose I've written a
post about similar issues before. I think I should reread my old posts more often because I pretty much took for granted arguments about Social Security and Medicare which I now know to be specious - more on that later. Here's a summary of what I'm going to write for those who don't want to read the whole thing:
tl;dr summary - We can't depend on traditional, life-long sources of wealth and income to provide for our retirement. Similarly, we can't depend on Social Security (for very different reasons than I thought years ago) to provide a meaningful post-work income. If you want to be ready for retirement, then you have to maximize your return on capital. To explain a bit more, let's look at personal finance through that age old economic lens of Land, Labor, and Capital. Conventional thinking about how one should live has the focus on the first two. You labor your whole life to generate income which is primarily invested in land (usually home ownership) and capital is a bit of a third wheel for extra savings, 401k, pensions etc. Historically, this is how American's have functioned since the end of WWII. Although the returns on capital have, usually, been higher than the return on land, it's been enough for a variety of reasons. Most of American's wealth has been tied up in owning a home. All of that is changing. The "housing ladder" has lost all of it's rungs and no longer contributes to a life-long growing equity stake in land. Wages and incomes from labor have been stagnant for damned near 30 years. Only capital can provide enough return to ensure the kind of retirement we've come to expect. Even worse, pensions are pretty much extinct and 401ks are being looted by the bankers. So go invest as much of your money in the stock market as possible. Don't know what to buy? Buy indexed stocks and low fee ETFs. Once interest rates come back to life and you can get returns greater than 3% or so, buy bonds and other longer term fixed growth investments. Why? Because nothing else is going to work.
Still don't understand? Here's a meme to help you figure it out:
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| In this case women are to be considered land. |
Now for the actual dissection.
Part 1: Social Security, and a funded retirement, are a subsidy to the young.
Retirement is kind of a new thing. For most of human history your life would pretty much look like this:
- You died in childbirth.
- You died in childhood.
- You made it! Into a life of toil a trudgery working for The Man until you died.
If you were really, really lucky you'd somehow become indisposed in your old age and simply couldn't work. Unfortunately, that usually meant you were either sick or senile and the burden of taking care of you fell on your children (because your wife died giving birth to one of those ingrates).
Something funny happened in, I dunno, like, the 1800s. The life of servitude and peasantry, which had defined life for just about all of the world's population since forever, began to transform into a slightly less bad form of servitude and labor, often in factories and other industrial settings. Extended families split apart and moved to cities, sanitation improved, education became a thing for everybody,
penicillin is awesome, yada yada yada, and the world after about a century of this looked a whole lot different.
All of a sudden we needed something to do with all these pesky old people (and it really wasn't that many of them back then but it was a lot more grey-hairs than they were used to). It didn't hurt that the Great Depression happened either. I mean, when 25% of your population is out of work, you start to come up with some pretty crazy ideas like: maybe old people should just be able to, you know, hang out? Until they die or something? That way we can give their jobs to the unemployed younger people. Wall-a!
Social Security is born. No more indigent old people. No more old people working until they croak.
As a side effect, we realized that a society which required the younger generations of a family to quite literally take care of the older generations was not as productive or happy. Let's put this into thought experiment mode. If you, right now, had to take care of your parents every need and expense, without any modern sources of retirement income, could you? What if you had to buy insurance for your parents or grand parents? What if you had to have them live in your home? Do you have enough space? Can you afford a bigger space? Can you pay for a private nursing home entirely out of your pocket? What if they needed around-the-clock care? Could you or your spouse afford not to work because you're caring for your parents? Because that's the world we'd be living in without Social Security and Medicare for the elderly.
What many people don't think about when they talk about Social Security and Medicare is that it is, in effect, a giant freedom subsidy to the young. Coverage frequently focuses on payroll taxes and the Social Security trust fund and whether costs are staying down. In part, that's because we live in a world where having a retirement is something of a foregone conclusion. We can conceive of a retirement that's substandard but we really can't conceive of not having retirement. Stories are starting to creep up, though, about the burden caring for the elderly is beginning to place on families. Keep that in mind when I move to the next section.
The broader point here, is that those Great Depression era people were really fucking smart when they thought things through - yeah, I know about WWII and Atom Bombs and so much racism, but that doesn't change the good ideas they had. They rightly saw that young people need to be free to choose to work and learn and have families and do the shit that young people do. Among many other major constraints which needed to be addressed, caring for the elderly was one of them. This theme, freeing productive citizens from counterproductive burdens, was a major aspect of social policy for the middle 20th century. Usually, this was done by the state imposing small taxes on the majority of the population (like our payroll taxes) to pay for the services or income distributed to the elderly, sick, poor, mentally handicapped, etc. While we always think of the tradeoff as being one in which the young are paying for the retirement of the elderly, we forget what the alternative is: the young take care of the elderly themselves. It's not much of an alternative.
Part 2: "Fixing" Social Security and the effort to destroy state supported retirement.
I put fixing in quotes because it isn't broken. But some very serious people want you to think it is. Indeed, the claims about Social Security's myriad problems are pretty much accepted as fact by both political parties. As I noted at the outset of this piece, I even agreed with them and wrote about it two years ago. I aim to correct that mistake here and to provide better guidance for my lovely friends and readers.
So what are these problems which the very serious people point to? Mostly, they argue that Social Security is going to run out of money. Mitt Romney famously called it a Ponzi Scheme. I can also remember Al Gore speaking about putting Social Security funds in a "lock box" during the 2000 election. Like I said, very serious people. They argue that the number of workers paying into the payroll tax system is not growing enough to support the increasing number of retirees being paid by the system. Other critics argue that Social Security is bankrupt now. Neither is true for two reasons. First, critics often misuse the Social Security Trust fund as a stand-in for the whole Social Security system. It's not. The trust fund is basically the collected surplus which has built up for decades because more people paid in than were paid out (also, Ronald Reagan raised the payroll taxes to account for the disproportionate number of boomers). When they say that the trust fund will no longer be able to fund 100% of benefits, they aren't mentioning that the benefits will then be paid out of Social Security's operating budget. What they also don't mention is that the trust fund will be able to pay the vast majority of the benefits for another hundred years or so. Without any action taken at all, the SS Trust Fund will pay 100% of benefits until 2033 and about 75% of benefits from there on out, for almost 100 more years.
Second, yes there was a second point, very minute changes can make the SS Trust Fund run a surplus pretty much forever. While the critics talk about cutting benefits to the elderly or about raising the retirement age (therefore taxing the younger workers who would end up providing the difference in care and income or slowing job turnover, respectively), the easiest way to bump up the Trust Funds' funds is to raise the payroll tax cap. Right now, only income lower than $110,000 is subject to payroll taxes. If you make more, no percentage is taken out for payroll taxes. Raise that cap (or eliminate it) and the Trust Fund is solvent for as far as we can predict budgets into the future.
But wait, James, didn't you say that the Trust Fund was just a surplus? What about Social Security's regular operating budget? Yes. What about it? Well, can't congress just fund Social Security out of its annual budgets? Absolutely, it can and should. Indeed, people keep trying to pass laws which require congress to include various programs like Social Security and Medicare in the budget. That way, they're always funded by the government and then the trust fund doesn't matter (except that it exists and will still cover 75% of costs for about 100 years). This is mostly opposed because covering 25% of the costs of Social Security after 2033 is seen as adding to the deficit which would ruin our economy because reasons.
Regardless of how you look at it or which approach you take, there are small ways to fix Social Security which don't involve shafting old people. Yet, both parties seem dead set on benefit reduction and raising age caps as the only way forward. Perhaps those are the only approaches both parties could agree on? Who knows, but don't expect the actions taken going forward to include expanding benefits to the elderly. When you retire, given the current political "wisdom", don't expect to get much in the way of support from the state if it exists at all.
Part 3: Home Ownership, the American Dream
Another big push coming out of the Depression and then again after WWII was home ownership. People my age grew up in a country where most people could expect to own homes. It's pretty much the staple investment of the middle class. Just about any man who got a stable job in his twenties could expect to own a decent home. Just like retirement, this is a fairly recent invention. Historically, most people lived on the land they worked either for themselves or, looking further back, for a land owning aristocrat. Just like there was no dream of retirement, there was no dream of home ownership. If they were paid, the pay wasn't enough to afford buying out the land baron or to buy land somewhere else. Again, this all started to change in the 1800s and really took off following WWII, especially in the United States.
As an aside, is it any wonder that a generation growing up in the Depression, coming of age on the battlefields of Europe and Asia, and living in adulthood under the specter of nuclear annihilation didn't seek to enrich only itself but to share the gains of growth more widely (unless you were black or a woman)?
So what does this dream of home ownership have to do with retirement? Well, it's called the housing ladder. The idea is, most people should utilize (or leverage, if you're being critical) the equity in their homes to progressively increase the overall value of their real estate holdings. It's a byproduct of equal parts culture, policy, and finance. Let's use an example which is supposed to be how the ladder functions.
A man, let's call him Erik, lands his first salaried job in his early twenties. Like all good American men, Erik seeks to buy a home and get going on the road to adulthood. So he does! Erik is a responsible fellow and is approved for a 30 year home loan of about $150,000 with a decent interest rate if he can provide a down payment of about 20% (this is traditionally the down payment required for normal home loans but that's changed in recent years). He finds the house that meets his needs and desires, pays the down payment which he's worked hard to save, and is now the proud owner of a fairly normal, if not nice, home. He budgets responsibly and pays his mortgage in full each month he lives in the home. A few years later, Erik is married and has just had the first of many children (2.5 to be exact). It occurs to Erik that his home isn't really big enough for a family and he begins the process of finding a new home. He makes a bit more money now, and he's dutifully increased his stake in his home's value (through paying his ~$850 mortgage) from the original $20,000 down payment to about $70,000. That means he can use the equity in his current $150,000 home to finance a down payment of $70,000 on a loan of about $350,000! And I'm not even taking into account a rise in the value of his first home which would net him even more money. And what about the debt owed on the first 30 year mortgage? Well, thanks to a helpful bank, eager to help him achieve his dream of home ownership, Erik gets it all rolled up into the new mortgage!
That's the start of the housing ladder. People, just like our hypothetical Erik, trade up two or three times over the course of their lives. Sometimes they profit quite a bit because the value of the home increased while they owned it. Sometimes they don't but the value of the equity they've got in the home still allows them to trade up. Over time, families throughout America followed this ladder from modest starter house to average white-flight suburb to fancy gated golf course community. Each time, the value of the land increased and their equity stake grew in value. If these people were responsible and smart, they'd make sure that the proportion of their equity was on track to outgrow the amount of money owed on the mortgage.
Maybe Erik's third home is only $400,000 and he had a higher income so the loan is proportionally much smaller the third time around. By the time Erik retires, he has paid off his mortgage completely and is living a nice home on a golf course in a gated community. His kids are grown. He and his wife are done with work and don't need such a big place. Like many Americans, they sell the large family home (now worth half a million dollars!) and buy a smaller, cheaper place for about $100k in a senior living community which is still gated and still on a golf course and still has very few blacks. They've cashed out the remaining $400k in equity and, combined with other sources of retirement income, live out the remainder of their lives. Their kids get to fight over whatever money is left over when they die.
When we look at retirement, we have to remember that Social Security was always only part of the plan for helping the elderly. It was basically a floor - retirement would only get so bad that seniors had to rely on the monthly check from the government and medical services covered by Medicare. The other major driver of a successful retirement was supposed to be home ownership. When Johnson pushed his Great Society reforms in the 1960s, home ownership was enshrined, at least in policy, as a public good. Not just because it was viewed as good for the economy and the productive young, but because they rightly judged that having a long term investment in your home and in growing your stake in the home you owned could ease the burden on the young and on the state in supporting your retirement. Even now, after the most severe housing crash since the Great Depression, most Americans' most significant investment is in their home. Even people with less than $1000 in savings (which is about 25% of the population) own homes. Importantly, home ownership was never supposed to be a panacea of wealth. Rather, it was strategy to get people to invest in themselves, their communities, and ultimately their children. Good schools, good public services, and good private amenities all led to increasing home values. Earning more money and improving yourself at work allowed better maintenance of the debt, the home, and the community. Good schools educated kids well, they went to college (ideally), and were able to climb the ladder themselves. The parents could leave some wealth to their families when they passed on. Did it work that way for everyone? No. But it worked that way for enough people, for a while at least.
Part 4: Home Ownership: The American Nightmare
Somewhere along the line, home ownership began to get very screwy. That ladder of ownership which served and focused the middle class's personal finances started losing rungs. The idea of owning a home as an investment changed from a generation long focus to a short term focus. The institutions which encouraged home ownership also encouraged speculation. Suddenly, that equity had to be used immediately. People borrowed agains the equity to get nice cars or renovate the house or do a ton of blow. Besides, it's not like people were making any money at work! Incomes were largely stagnant since the mid 80's. At the same time, the idea of a down payment went out the window. Since lenders were busy lending to anyone because they need more mortgages to feed the Wall St. securitization machine, they didn't care about the whole reason behind a down payment. Not just to prove creditworthiness - a down payment is a sort of nest-egg. Ideally, it grows with you. Not only did we blow up the whole economy betting on houses and stuff (but oh god the cocaine!) we destroyed the utility derived from traditional home ownership. People believed that they really should live in $500,000 homes as a first home. Even after the crisis, people are still thinking that way.
Tellingly, the way we sought to fix home ownership was both short term and did nothing to help families rebuild their finances. We promised thousands to first time homebuyers, essentially subsidizing the behaviors which we ought to discourage. We created programs to keep people in homes which, although humane, prevented price discovery and benefitted only the banks that foreclosed on them anyway.
The boomer (worst) generation that's been retiring for the last few years is hitting the ugly reality of not having strong home values or large equity stakes. Hell, many of them were playing so loose with their finances, they they forgot to pay off their mortgages, and second mortgages, and car loans, and coke dealers. They're retiring in debt! Even if they sell the houses, they could be underwater (meaning they still own more then the house is worth) or barely break even. Thule, the scary guy who hangs out with the coke dealer, is just happy to break knees, but the banks want to break spirits.
Not only that, but flat wages and high unemployment meant that the young people waiting to buy homes, couldn't find any to buy. They couldn't get financing because of the collapse in lending after 2008 and they couldn't compete with the hedge funds buying up houses to rent during the 2010-2013 "recovery". Not only that, but the finances of the new working generation, my generation, are largely garbage thanks to lots of school debt, poor employment prospects, and their broke parents.
The housing industry depends, in a large part, on the idea of the ladder. If a whole generations of 20 somethings aren't buying houses and trading up a few times over the course of their lives, the industry is in trouble. They are basically going to have to cater to the few wealthy enough to buy and the majority who can only afford to rent. Millionaires, slumlords, and the rest of us! The American Dream of home ownership.
Part 5: Income (LOL)
I'm not sure that I have to write anything here. If you haven't heard that incomes have been stagnant for, like, 30 years then you haven't been paying attention. instead of rehashing what should be obvious to anyone with a pulse, let me shorten up this section by saying that low and stagnant incomes make saving for retirement damned difficult. Also, to some extent, the money you earn at your first job is a predictor for future earnings. If you are making minimum wage at 28, it's not looking good for your earnings at 68. The fruits of your labor have not been worth so little since, well, since the Depression, I suppose. Without income form the state or income from cashed out home equity, what does that leave people to retire on?
Part 6: Investment
Here's a fun story. One of my former roommates was dating an accountant. She had just graduated with her Master's in Accounting and was making good money at a large firm. We were all having a discussion one night - me, pessimistic as usual, and ranting about the economy. I guess, since economics is kind of a hobby of mine, the Accountant asked the English Major, "What is an IRA and how do I buy one?".
I was, needless to say, gobsmacked. One does not simply
walk into Mordor buy an IRA. "The A," I explained, "stands for Account. You just go to a bank and ask to open one and deposit up to $5,000 a year. Then you invest that money into whatever you like."
"Oh," she was clearly puzzled, "It's just that, as part of my job I go to local schools and teach a personal finance class. We just did a lesson on retirement and IRAs and it says that if you put in the maximum amount every year starting at age 24 you will have like $2 million."
"At what rate of return?" I ask.
She got the packet from her bag and sure enough, the IRA worksheet assumed a 6% rate of return, annually. The Master Accountant, explained that she thought it was a security or bond with a fixed rate of return. In the full light of understanding, she and I then had a conversation about whether or not she was lying to the youths and why we have a financial education system in which Accountants don't lean much, if anything, about personal finance.
I'm not trying to pick on this person. She was a sweet girl and meant well. I'd imagine that she probably did open an IRA and hopefully invested well because this was 2009 so she would have had a good ROI since then.
Instead, I think that the story about rate of return is an important one. Compounding interest and dividend reinvestment are the most powerful force in personal finance yet most people know almost nothing about them. Maybe, just maybe, they remember compounding from math class and can apply it to finance. The IRA, contributed to and compounding at 6% is a good example. Although possibly misleading, it shows how modest annual investment can yield great rewards over the long term.
But how do you get a good return on investment? Well, who fucking knows? That's the whole point. It's not guaranteed and anyone who tells you he knows how to invest and always make money is going to jail because they're running a Ponzi scheme. But what I do know is this: the rules and taxes governing finance and investment income have been written to the advantage of those who have investments and earn income from them. While the ever shrinking fruits of your labor are taxed at 20-25% (for a middle class income, at least) the income from investments is, in many cases, protected. Certain types of retirement accounts are tax sheltered. Dividends are taxed at a lower rate than income. Capital losses can be written off for up to $3000 a year and, if used carefully, can offset gains. Not only that, but sometimes the underlying assets go up. Hell, the stock market was up like 30% last year. Even if you "merely" matched the market, you gained 30%!
Of course, your ability to invest is constantly under attack. Slowing or absent wage growth is one culprit. You can't invest what you don't have. Second, employer contributions to 401k accounts are disappearing. Where they used to match your contributions is some form or fashion, now they may not match at all. That extra money is especially important early on in your working life (because of the compound interest). Third, 401ks are often overly limited in the kinds of accounts you can invest in. Sometimes you can only pick from a small set of mutual funds which charge high fees. In a few cases, the fees are even high enough to wipe out your gains. This is happening with one of my wife's 401k accounts from when she contracted at CDC. Forth, unfortunately, the price of that "choice" of plans is fiduciary responsibility. That's right, you picked that plan, so the company and the company who manages the fund aren't under any responsibility to actually grow your money. Even worse, the markets have been strong for a little while but the funds used in many 401ks have vastly underperformed the market. Your retirement is getting picked clean at each step. All you can do is open up your own retirement accounts to invest with and hope your 401k isn't looted to badly.
Even worse, many young people are graduating with high levels of debt. That both sucks up money which could be used for investment and serves as a kind of disinvestment - draining away much, if not all, of the gains from investments elsewhere.
Part 7: Conclusion
So great, you've read all of this and seen that there's basically nothing to help you in 50 years when you retire. What should I do, James, what should I do? You are screaming at the computer right now. Well, you should do your best to emulate the habits of rich people. And I don't mean that in the Paul Ryan culture-of-dependency right wing kind of way. I mean that in the personal finance kind of way.
Here's why: the rich have gamed the system. (See yesterday's supreme court hearing.) Decades of slow changes to the way that our nation regulates finance and taxes the wealthy have made investment income the least taxed form of wealth. Owning money is the best way to get money. Capital, in other words, is cheap. If you are able to, invest in things like a rich person. Can you dump millions into securities? No, but, as the IRA example above shows, millions are not necessary. You aren't trying to invest to turn a quick profit; that's called trading. Investing is over your whole lifetime. From working age 20 something to your retirement. And nothing comes even close to stocks over a 50 year time frame. While that's not a guarantee, it's what the rich are doing and they are making the rules to their benefit. Why swim up stream when the Salmon are all swimming down?
What about housing? Well, I'm not opposed to home ownership but, if you are dead set on owning a home, try to do your best to follow the housing ladder. Don't buy until you can afford a significant down payment or in all cash if possible. I don't care if you're 35 and buying your first home. That extra equity can be a lifesaver if the market goes under and you're selling at a loss. Don't go for a mortgage which is going to make you "house poor"; i.e. all of you money is just going to house payments. In other words, you don't need the expensive house in the good community right now. Additionally, buying that first house has a ton of fees associated with the realtor, signing costs, loan fees, inspections, taxes, etc. And don't forget that houses are expensive to maintain and it's all at the cost of the owner. Plus, there's no guarantee that you'll get a profit out of it (which is, again, why building equity was an important aspect). Land, in other words, is expensive. Also, this is just my 2 cents addition, if you
know you're going to be moving out in 3-5 years, don't by a house. Prepare to live in a home for a decade or more and only move if the situation is right. Otherwise you're just treating it like another bad investment.
Work like a dog and try to earn more when possible. I know it seems impossible now but our generation has to get out of the barista jobs and into the offices of the world. Without relatively stable, salaried income, planning for retirement is impossible. Labor unfortunately, is cheap for those who own capital, and expensive for the rest of us. The jobless recovery will, hopefully, not last forever. As an alternative to investing, pay down your debts as quickly as possible. In the land of the blind (debt slaves) the one eyed man is king (debt free).
Lastly, spread the word about Social Security and other benefits for the elderly. They're not broke or bankrupt. They don't represent a major debt burden for the taxpayer unless we purposefully botch the funding. There's no need to cut benefits or raise the retirement age when small fixes now can maintain it in to perpetuity. And, remind people that social plans like these are, in reality, a subsidy to the young. Nobody thinks this way and we need to change the language of the debates. If the state steps out, younger generations have to step in (because, we're really nice that way) which drains our time and resources. If we want retirement to exist when we're old, we have to protect it now. If we want our children to have lives of their own - not just care for us all day while we piss ourselves and yell about the good-old-days, then we need to be prepared.
Vote for candidates who want to strengthen Social Security. Don't buy a house just because that's "what you do when you grow up". And for goodness sake, invest every spare penny because that's, oddly enough, the safest bet you can make. And then don't touch it for 50 years.
Old way of thinking about an individual's productive assets: Land>Labor>Capital
New way of thinking about an individual's productive assets: Capital>Labor>Land
