Retirement Rescinded – Part One

What is the likelihood you’ll receive in your retirement the amount you anticipated?  And just how safe are your retirement funds?

It should come as no surprise that all retirement plans depend on earning returns on the principal while funds are being added during working years as well as when funds are being withdrawn during retirement.  If those earnings are below what was anticipated, then the plan has been under-funded and something has to give.

I’ve previous discussed in this blog the massive under-funding of government retirement plans and, indeed, health care plans such as Medicare. Anyone who is not aware that these programs are in serious financial trouble is just not paying attention — or just doesn’t want to think about it.

Even Alan Greenspan, not one of my favorite persons, is sounding an alarm, “Alan Greenspan, former chairman of the Federal Reserve, said the global economy’s inability to produce goods and services efficiently is going to cripple the ability to pay for pensions and health programs for the elderly.”  Alan, where were you when the alarm needed to be sounded at least a couple of decades ago?

And a sluggish economy contributing to reduced investment returns is only one of the problems besetting these government programs.  Over-promising benefits would be another.

Okay, so chalk off Social Security and Medicare.  Not entirely, but at least at their promised benefit levels.  That’s strike number one against our current and future retirees.

Plans sponsored by businesses and unions aren’t in much better shape as the 400,000 members of the Centrals States Pension Fund have learned.  As I’ve pointed out before, this education regarding under-performing pension funds is going to be spread far and wide in the coming years.  Central States is just one preview of coming attractions. Grandmas and grandpas today are not going to have as carefree of retirements as my grandparents enjoyed simply because defined benefit pension plans have not generated the returns needed to provide the benefits at the levels promised.  Strike two.

But what about IRA and 401k plans? What’s the deal with these?

Well, to start off with, there’s a mindset out there bordering on hysteria that suggests that these retirement funds might be frozen, seized, have their terms changed by government regulation, or otherwise rendered less valuable than anticipated due to a national financial crisis. Lurid possibilities are presented typically accompanied by the recommendation that folks should close these accounts, take the tax and/or penalty hits, and stuff the money in gold bullion held personally. Nonsense.

Well, almost nonsense. Sort of.

I’ll assume my readers know what 401k and IRA plans are.  If you’re unclear, just click on the terms in the previous sentence and the folks at Investopedia will get you up to speed. These plans offers a highly desirable means for building funds for retirement unmolested by taxation until it’s time to draw out funds in the golden years.

So what can go wrong?  Plenty.

First, a 401k or IRA can suffer from the same problem as the other retirement plans I just mentioned – investment returns below expectations resulting in either an accelerated draw-down rate during retirement, or a shortened time horizon over which the retiree can expect to receive benefits.

Second, if you are paying someone to manage this for you, they are taking fees which reduce your returns. Of course those performing this service deserve their pay, especially when successful. Advisers will have several model portfolios and will recommend the one that their research indicates looks best for your particular situation.

That said, I believe there is a bias present which defines success as beating a particular index. Which means that if the index to which your fund is compared drops by 4% and your fund drops by 3%, your investment is deemed a success for the relevant time horizon.

There’s also a long-term investing bias. For those beginning their investment careers, this can be a great thing, and these folks get to buy low during market corrections.  (We are no longer allowed to have “crashes.”)  And one can take the perspective that the deeper and longer the correction the better – when you’re young.

But if you’re 60 t0 65 and your fund takes a 35% haircut, it will be years before you get back to even.  This will result in sleepless nights.  And the possibility of corrections in the amount of 35% or more have not been repealed.

I’ve said it before, people do not realize how risky common stocks can be. And if your IRA or 401k are full of the things, your retirement, to the degree you are depending on withdrawals from those funds, is in danger of disappointing very badly.

I will quickly be remonstrated for not pointing out that folks near their retirement years should have a very different portfolio than someone who’s 25. Okay, I just pointed it out, and I agree.

But I will also point out that this is not my grandparents’ market where satisfactory returns can be earned on 10-year treasuries, bank certificates of deposit, and utility stocks. Try stuffing your fund with those now and you had best have a much larger principal on which to draw interest and dividends than most have.

So people chase yield.  Or attempt to trade the equity markets in their retirement funds in the hope of ramping up the return to something that allows withdrawals to provide the living standard they had hoped for when they started the plans.

I’m going to let those thoughts sink in for a while before I continue with some specific reasons I dislike IRA and 401k plans – which I’ll do in Part Two.





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