Conventional wisdom in the 1990s told people saving $1m would be enough for retirement – today, that’s not enough
When I got my start writing personal finance in the 1990s, it was conventional wisdom to tell people that if they could save and invest their way to $1m – via their 401(k) and other retirement accounts – their golden years would be a glorious event. They could travel, indulge in a hobby, visit the grandchildren … no worries.
But that was before the Internet and housing bubbles blew up and burst. It was also years before the Federal Reserve, desperate to keep the American economy from stalling out, brought interest rates down to near zero, reducing interest on savings accounts.
Today, $1m is not enough. And that’s the subject of the somewhat problematic article “For Retirees, a Million Dollar Illusion” published by The New York Times this past weekend.
That’s right. Even if you have $1m on hand, you can still die broke.
The issue is one of interest rates, withdrawal rates, and investing to preserve principle.
Most people, as they come to the end of their working years, are advised to favor safety instead of bigger returns. Bonds were long thought to be the way to do this without running out of money or risking a lower quality of lifestyle in retirement.
How could you go wrong?
But look at the returns on those bonds. In 1995, the interest on a 10-year Treasury note varied between 5% and almost 8%. Ten years later, it was about 4%. This week, as you are reading, it is just over 2%.
As a result, we get this line in that article this weekend:
“Consider this bleak picture: A typical 65-year-old couple with $1m in tax-free municipal bonds want to retire. They plan to withdraw 4% of their savings a year – a common, rule-of-thumb drawdown. But under current conditions, if they spend that $40,000 a year, adjusted for inflation, there is a 72% probability that they will run through their bond portfolio before they die. Suddenly, that risk-free bond portfolio is looking risky.”
The piece goes on to say that a safe withdrawal rate for a $1m portfolio invested in bonds is – drum roll please – 2%. That’s $20,000. As for the median household, which the New York Times quotes New York University professor Edward Wolff as saying enjoys a net worth of $10,890, my calculations tell me that if they draw down 2% of their savings, their savings will offer them an annual $217 supplement to their Social Security.
The article goes on and on, revealing other scenarios of the sort designed to simultaneously keep the average 50-something bolting awake in panic at three am. Numerous strategies are evaluated on their odds to keep money in the Fidelity account till the very end – more stocks can boost performance, but increase volatility, not to mention the potential for great losses.
The final conclusion: the longer one can work, the better the odds of not running out of money for the very common sense – if somewhat gruesome – reason that “you won’t have as long to live on your savings.”
There has to be a better way. On that note, I’d like to point out a few facts The New York Times unfortunately skipped over.
First, that $1m portfolio was a myth from the very beginning and shame on all of us (and, yes, I include myself among this number) for pretending otherwise.
Whether you could live on $1m in retirement was always an academic question for most. Most Americans don’t even have $100,000 stocked away.
Moreover, the folly of expecting Americans to put $1m aside on their own volition did not suddenly became obvious in the post-2008 world, when the economy all but collapsed and interest rates plunged.
As I discovered while reporting my book Pound Foolish, the great 401(k) critic Teresa Ghilarducci called the American do-it-yourself retirement system “an abyss” in testimony before Congress in 1994:
Shifting responsibility to workers and bullying them from the pulpit to save like professional money managers … will encourage the high-income, not the low, to save in individualistic ways, grow a whole industry of vendors, and divert human activity toward tending to asset allocation and mutual fund performance.
And Ghilarducci, as it turned out, was optimistic. Even high-earners are likely to be at least somewhat dependent on Social Security in their old age. As Wolff said in the Times’ article, “The bottom line is that people at nearly all levels of the income distribution have undersaved.”
Let’s take this term “undersaved.” It’s all but impossible to save enough money for a 20-to-30-year period of staying out of the workforce. That’s probably true anywhere, but it is especially true in the United States. The cost of things ranging from healthcare to housing to raising children has gone up at rates well beyond that of inflation for long periods of time, even as salaries stagnated and fell relative to that same inflation. Financial problems were not caused by latte addictions, but by the need for Lipitor.
And when you throw in the fact that not many of us are noted for our ability to predict the future and invest appropriately, you have the formula for a future retirement crisis. I mean, is it really appropriate to ask small, often unwilling or reluctant investors to figure out the various interest rate and investment scenarios the article tossed out for consideration?
And that, in turn points to a deeper problem with The New York Times article: it seems to accept the current retirement status quo as the natural order of things, ending with a suggestion that we begin to cut back in our fifties so we don’t “get accustomed to a lifestyle that you won’t be able to afford later on.”
However, there is nothing inevitable about the way we save for retirement. It has changed in the past, and it can change again.
The 401(k) was never meant to be anyone’s primary savings vehicle. It originates in a 1978 shift to the tax code meant to allow high earning corporate executives to put more of their salary in savings accounts on a tax deferred basis.
Yet we grew to depend on the 401(k) as our retirement savior. In the early 1980s, more than 60% of us were potentially eligible for a pension. Today, more than 60% of us only have access to a do-it-yourself retirement-deferred contribution plan.
Other countries do it differently. Look at Australia. Australia requires employers to contribute 9% of their employee’s salaries to a set-aside account, where it can be invested in a variety of ways. How effective is it? Well, as a recent report issued by the Center for Retirement Research at Boston College put it, “Australia’s retirement income system has produced high levels of individual saving and broad coverage at relatively low cost to the government.”
That sure sounds better to me than telling 50-year-olds to cut back now so they don’t get used to living the good life.