Tuesday, September 1, 2009

Retirement Planning: Change is Worth Thinking About

I enjoy a good controversy. Actually, I love a good challenge and nothing like change gets the old blood moving through the veins. Perhaps that was the idea of a recent New York Times opinion on how to get more people to retirement with more retirement money. Is it possible that simply guaranteeing a portion of those investment (you will often hear it referred to as savings, which it is not yet) dollars would be enough?

Not everyone thinks so. But then not everyone has thought it through. The opinion set-up the controversy by suggesting that there should be some way to help those who have not put enough away by guaranteeing that some of it would be there when they retired. To do this would not be a difficult as one might imagine.

But first, the critics. Charlie Farrell at CBS MarketWatch offered up some pointed criticism of the suggestion, made by Gary Burtless of the Brookings Institution. Mr. Burtless is no slouch. In fact, he is a senior fellow that researches labor market policy, income distribution, population aging, social insurance, household saving, and the behavioral effects of taxes and government transfers. He was also an economist with the U.S. Department of Labor. His research has led him to make the following conclusion: the government needs to guarantee retirements.

Mr. Farrell suggested that there would be a moral hazard to such an action. People bought stocks even when they knew (even if they couldn't remember the lessons previous downturns have taught us) the risk was high. Any sort of guarantee would encourage additional risk as people put even more money into a market rife with volatility.

Wall Street would step up to the effort by increasing risk in new products designed to tap the inexperience of these investors. This is to be expected, in part because Wall Street realizes that for every savvy investor who reads between the lines, understands the risk and their tolerance to it and can acclimate their portfolios to these sorts of challenges will not be easily sucked into a riskier venture.

But Wall Street doesn't exists for these financial thinkers alone. Instead, the inexperienced, the unwary and the investor who wants to follow the market wherever it may lead, is the bread and butter of this industry. To use "moral" in the same article as Wall Street may be enough to qualify for the later group as the easily duped investor.

This sort of backdoor guarantee would undermine how America does business. Apparently, Mr. Farrell believes that an individual who uses mutual funds (the most common investment in a 401(k)) would find their fund manager - although he never does suggest it will be the much more experienced fund manager who will make this mistake - buying into companies with no value. Mutual funds live and breath and survive based on performance and how investors perceive that performance. In this instance, Mr. Farrell's worry is outsized.

He believes that the government will be left holding the bill as soon as the next disaster strikes.

But that is, in all likelihood, not how it will unfold. Three things will need to be understood before any such plan could take effect - as there is currently no plan in place.

First, the 401(k) would need to be recognized for what it is and what it is not. It is portable (but only in the sense you can roll it over into an IRA, where the continued contributions to it are considerably lower). It is investing (and all investing requires risk in some way shape or form to be considered investing). Risk is a moving target (that needs to be evaluated and reevaluated frequently; some call it asset allocation or even re-balancing a portfolio). It is not savings.

Second. the 401(k) is still a rich man's tool that we are permitted to participate in. It always has been and always will be a line of tax code for high earners to sock away even more money for their future. Ask the guy or gal sitting next to you whether they max out their 401(k). Then ask them if they know any one who does. This is a grass roots survey that is as good as any on the subject. Safe money would wager that they don't.

Third. Any such guarantee would be called a pension. This takes the money out of an workers paycheck - pensions traditionally make the contribution in addition to your income - and in theory, invest it conservatively. If the government were to suggest that the employer match would be placed in a pension (if you have one, it is placed in your 401(k) and often referred to as free money) and that the government step in and match that contribution, much of the risk would be removed. The company wouldn't want any more risk than is needed to grow the money and the government could suggest conservative investments that might suit both the nature of the business and the best interest of the country.

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