Category Archives: Retirement

The Fallacy of Financial Education

By James Kwak

In White House Burning, there is a section on the rise and political influence of the conservative media. At one point, I looked up the top ten talk radio shows by audience. Nine of them were unabashedly right-wing, politically oriented shows. The tenth was Dave Ramsey. Ramsey has plenty of conservative elements: religion, moralism, glorification of wealth. But his show isn’t about conservative politics. It’s about personal finance.

Ramsey is a huge success because—in addition to his charisma and marketing skills—he is peddling one of the huge but popular illusions of American culture: that people can become rich by making better financial decisions. He’s also one of the characters skewered by Helaine Olen in her recent book, Pound Foolish, which describes the fallacies, hypocrisies, and borderline-corrupt schemes of personal finance gurus like Ramsey and Suze Orman. It’s a fun read—a bit repetitive, but that’s largely because all personal finance “experts” are pushing a small handful of myths.*

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“Retirement Security in an Aging Society,” or the Lack Thereof

By James Kwak

James Poterba wrote up a very useful overview of the retirement security challenge in a new NBER white paper. (I think it’s not paywalled, but I’m not sure.) He provides overviews of much of the recent research and data on life expectancies, macroeconomic implications of a changing age structure, income and assets of people at or near retirement, and shifts in types of retirement assets.

In the past, I’ve used the Federal Reserve’s Survey of Consumer Finances as my source for data about the inadequacy of many households’ retirement savings. Poterba has a new, perhaps even more stark snapshot:

Screen shot 2014-03-04 at 2.20.32 PM

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The Costs of Bad 401(k) Plans

By James Kwak

Mixed in with blogging about this, that, and the other thing, it’s nice to occasionally write on a topic I actually know something about. 401(k) plans and the law surrounding them were the subject of my first law review article (blog post). They have also been in the crosshairs of Ian Ayres (who simultaneously works on something like nineteen different topics) and Quinn Curtis, who have written two papers based on their empirical analysis of 401(k) plan investment choices. The first, which I discussed here, analyzed the losses that 401(k) plans—or, rather, their administrators and managers—impose on plan participants by inflicting high-cost mutual funds on them. The second, “Beyond Diversification: The Pervasive Problem of Excessive Fees and ‘Dominated Funds’ in 401(k) Plans,” discusses what we should do about this problem. To recap, the empirical results are eye-opening. Screen shot 2014-02-25 at 3.21.48 PM This table shows that 401(k) plan participants lose about 1.56 percentage points in risk-adjusted annual returns relative to the after-fee performance available from low-cost, well-diversified plans. The first line indicates that participants only lost 6 basis points because their employers failed to allow them to diversify their investments sufficiently. The big losses are in the other three categories:

  • Employers forcing participants to invest in high-cost funds by not making low-cost alternatives available
  • Investors failing to diversify their investments, even when the plan makes it possible
  • Investors choosing high-cost funds when lower-cost alternatives are available

Now you could say that the latter two sources of losses are the fault of individual plan participants, but that is cutting the employers (and the plan administrators they hire) too much slack. In particular, administrators should know that, if you offer both an S&P 500 index fund and an actively managed fund that closet-indexes the S&P 500 for 120 basis points more, some people will put their money in the latter. Continue reading

Rich People Save; Poor People Don’t

By James Kwak

It seems obvious. Yet it’s often lost, both by the scolds who lecture Americans for not saving enough and by the self-appointed personal finance gurus who claim that anyone can become rich simply ye saving more (and following their dodgy investment advice). Saving is sometimes seen as some kind of moral virtue, but from another perspective it’s just the ultimate consumption good: saving now buys you a sense of security, insurance against misfortune, and free time in the future, which are all things that ordinary people don’t have enough of.

Real Time Economics (WSJ) links to a new survey being pushed by America Saves (which appears to be a marketing campaign run by the Consumer Federation of America, which seems not to be evil*). According to the survey, there are significant differences in savings rates and accumulated savings between lower-middle- and middle-income households. And that’s treating all households in the same income bracket as being alike, leaving aside differences in family structure, cost of living, etc.

I’m all for living within your means and saving for retirement and all that. But it’s a myth to say, as America Saves does on its home page, “Once you start saving, it gets easier and easier and before you know it, you’re on your way to making your dreams a reality.” The underlying problems are stagnant real incomes for most people, rising costs (in real terms) for education and health care, increasing financial risk due to the withdrawal of the safety net, and increased longevity (good in some ways, but bad if incomes aren’t rising and you want to retire at 65). That’s why households are showing up at age 64 with less in retirement savings than they had just last decade. And why, if you feel like you’re not saving enough, it’s probably not your fault.

* But America Saves itself is supported by a bunch of financial institutions and trade associations like the Investment Company Institute, which have a vested interest in getting people to entrust more money to them.

Small Steps, but Not Nearly Enough

By James Kwak

Floyd Norris says some sensible things in his column from last week on the retirement savings problem: Defined benefit pensions are dying out, killed by tighter accounting rules and the stock market crashes of the 2000s. Many Americans have no retirement savings plan (other than Social Security). And the plans that they do have tend to be 401(k) plans that impose fees, market risk, and usually a whole host of other risks on participants.

But even his cautious optimism about some new policy proposals is too optimistic. One is the MyRA announced by President Obama a couple of weeks ago. This is basically a government-administered, no-fee Roth IRA that is invested in a basket of Treasury notes and bonds, effectively providing low returns at close to zero risk. The other is a proposal by Senator Tom Harkin to create privately-managed, multi-employer pension plans that employers could opt into. The multi-employer structure would reduce the risk that employees would lose their pension benefits if their employer went bankrupt.

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