If there was one thing the world’s retirement industry didn’t need now, it was the CoronaVirus. The $30 trillion monolith had already been collapsing under its own weight of advancing medical services and technology and increased longevity, on one hand, lower birth rates and a breakdown of nuclear family support on the other. Consequently, with less and less people paying for more and more, the end was soon to come, anyway.
And now, with social insurance/security/welfare agencies scrambling to pay for the immediate covid-cost, it seems that the greatest pyramid scheme in history is about to be swept down the Nile.
How did it all begin?
Retirement is a rather recent concept -certainly too young to die of infirmity. And yet, altruistic as intentions may have been, human nature and the march of civilization apparently bore down upon it harshly.
Further examples include the 17th Century Ernest the Pious, but the idea never quite caught on until Otto Von Bismarck’s introduction of a state-funded pension for anyone over 65 (and disabled soldiers, of course).
Not to be undone, the British introduced the Old Age Pensions Act in 1908 – a welcome departure from the 15th Century Vagabonds Act that still had beggars and orphans sent to workhouses. Following the US Civil War veterans were already receiving a pension when, in 1875, the American Express Company began providing its pensioners with a wage. Kodak came soon after (continuing to pay till this day despite the company’s near demise in 2011). Municipal workers, police and teachers were the first public employees to join the party. And in 1935, F. D. Roosevelt introduced his Social Security Act – the last to be introduced throughout the industrialized world.
Meanwhile, the stability of these funds was demonstrated when, during the Great Crash of 1920, less than 3% of pension funds collapsed. That truism was soon put to pasture when, in 1963, the Studebaker car company became the first major corporation to go under, taking its employees’ privately administered pension funds with it. Still, Congress heard the cries of its civilians, and enacted the Pension Benefit Guarantee Corporation 10 years later, which by 2010 was making up for the failings of over 1.3 million corporate-held pension funds. Clearly, this did not help the workers of GM, Chrysler and others several years later; and the problem was universal – as Robert Maxwell proved in Britain when he stole his workers’ £400 mn. pension fund.
The situation is no better in the government sector, where – despite being guaranteed by the state budget – less and less people are willing to cover the pensions of less than 1% of the population, whose funds were created taking into account 8-12% interest rates. Indeed, in 2013, the city of Detroit filed for bankruptcy, and other municipalities are having a hard time making good on their promises of employee security.
Studebaker – the 1st major US corporation to take down its employee benefits into bankruptcy…
The Beginning of the End
Given an average lifespan of 80, a quick computation shows that a person needs to save about a third of his/her salary during 45 years (20-65) of active occupation to pay for 15 years of retirement (obviously retirement expenses are usually less than a person’s last pay-check, but – then again – nobody makes at 20 what he/she will be making at 50). Since nobody really does that, the shortfall must be taken up by those still in the workforce while a pensioner continues ambling along his/her happy business. This, of course, makes for a pyramid that soon topples, quite simply because it is constructed in quicksand.
If in the 1950s heyday of economic bliss, there were on average about 7 people in the workforce paying for each retired individual, today it is half that – 3.5 and expected to drop to 1.2 by 2050. And where, oh where, is the money to come from for those younger offspring, presently busy funding the foibles of their retired fore-folks?
Adding to that, innocently trying to cover the shortfall by investing what money they do have in riskier assets, pension funds have often found themselves – like the average binaries option scapegoat – bankrupt. In fact, following the 2008 financial meltdown, US corporate pensions plummeted from their previous $86 billion surplus to a $217 billion deficit.
But that 3-decade-long 75% decline in the US, where population replacement is still healthily rising, is easily followed by Europe and Asia, where population replacement is close to zero, if not contracting. Declining interest rates, decreased government funding, financial earthquakes that seem to hit us once each decade (at best – this latest viral attack actually gave us a 12-year respite) mean that, what was once a healthy financial endeavour (operating an honest retirement fund), is now a losing battle.
Consequently, in the US, where the Wall Street Journal reported that in 2017 only 13% of private sector employees had a retirement plan, IRAs have become the latest fashion – tax-deductable Individual Retirement Accounts that are administered by a Bank, a Mutual fund companies, Brokerage firms, Life insurance companies and Robo-advisor websites.
Pensions go Private
Facing a rising tide of calamity, the OECD in 2002 set out a set of guidelines regarding a pension-funds regulatory body. The result in most countries is a set of strict requirements to ensure solidity and non-reliance upon government budgets. Adherence to these provides – in return – government agency underwriting and guarantees. These include employee vetting, portfolio composition, regular reporting, and so on. Outsourcing does not absolve the fund managers, and each decision must be carefully elucidated and rationalised, based on expert opinions.
But people are easily led astray, and the greatest obstacle to creating, maintaining, subscribing to and utilizing a pension fund is – as with almost everything financial – knowledge. Ironically, most of the studies mentioned herein stress that those who require it most – people from lower socio-economic and less educated classes – are those that have not an inkling of what a pension fund is, why they need it and how to go about creating one.
Based on data from the US Employee Benefit Research Institute, less than a third of employees actually give retirement any thought. Less than 40% have tried to make the required calculations. 70% depend on their investment/insurance agent, and the problem is even compounded by changes in the workplace.
At present, the US workforce is comprised of 35% freelancers. At its present rate of growth, the majority of US workers will be freelancers by 2037. Add to that the gradual shift towards micro-jobs – short-term employment based on short-term specialization – and it is clear that less and less people have an employer who opens and maintains their pension funds.
DIY Pension Plans
If before, we mentioned the absurd ratio of savings to withdrawals regarding pension plans, we need also to remember that the days of 8% interest days are over. Thus, any fund based upon that becomes immediately irrelevant, since a quick calculation will show that every 1% reduction in ROI requires a 10% increase in wage savings. As a benchmark, consider that until recently, the average earnings yield on S&P-based instruments was about 4.7% – a benchmark sorely stripped of any paint by the Coronavirus.
In short, creating your own pension plan is – at best – a thankless task. And yet, it is one that we will all gradually have to master and implement.
Now, the profusion of “how to” guides on retirement is staggering. Unfortunately, most of them deal with how to spend yo0u spare time, how to lower your standard of living, how to postpone retirement, what financial advisers to turn to… in short – how to spend it, not how prepare for it.
Let’s take a look behind some of the basics:
What is a Portfolio
A portfolio (from the Latin porta folium – where one carries one’s sheets/leaves/papers) is simply a collection of assets – both physical and equitable, assets and derivatives. A retirement portfolio must be balanced – more so than a regular savings portfolio. Growth must balance withdrawals, when they come about, so that earnings on equity (what the portfolio is worth) continue to supplement the principal (what you’ve paid in).
In general, it should look something like this:
The basic guidelines here are:
- A fixed salary from age 20 to 70 (obviously this is merely a simplification)
- A 26% savings ratee
- A fixed 8% interest rate (again, for the sake of illustration)
- A 60%-of-last-salary withdrawal rate.
What we see here is a principal that grows each time we add to it (contributions), and an interest level that is almost imperceptible – even at the unheard of 8%, and an equity that is the sum of the principal and interest, but which begins to drop as one begins to withdraw. Despite that, however, one continues to gain interest – albeit on a shrinking equity – after one ceases to contribute and begins to withdraw. The idea is for equity to hit zero at or (preferably) after one’s demise (one would rather leave some in the till than have no income before one trips off to a better place).
Whichever way you look at it, you will need to be earning more on your equity than most bank accounts and equity funds offer, nowadays. The quick response is: gambling – the higher the risk, the higher the reward (and loss, of course). Now, this should not be dismissed out of hand. In fact, what most retirement funds do is invest your capital in riskier assets the further you are from retirement, gradually shifting towards more secure instruments the closer you get to requiring your funds. With a wide scope of clients, they can afford to offset the risky losses from one account with the risky wins in another – provided they are not entirely inept.
To create your own fund, the first thing you will need to do is open an account with a broker who offers a wide range of assets and derivatives, the latter which will enable you to invest on margin in both the rising and falling values of those assets. Trade360 is a good example, especially considering the atypically wide range of both stocks and ETFs. In cases like this, a company’s longevity is a true gauge of reliability, as is the fact that Trade360 is regulated throughout both Australia and the European Union.
The second thing that must be done is to take stock of your future income: your fixed assets, social security income and other plans and savings, and deduct those from what you will one day require.
Now comes the fun part: investing it. We’ll for now suffice in focusing on shares, which can be risky, bonds, which rarely are, and cash – the benchmark. To assist you, there are several online calculators showing that a conservative portfolio (20% shares, 50% bonds, 30% cash) held for too long may not suffice, while an adventurous one (50% shares, 40% bonds and 10% cash) may crash.
Let’s take a closer look:
We all know by now that bonds – especially government bonds when the air is germ-free – are the most stable of assets. Beneath these come investment-grade bonds, which provide a higher annuity but are slightly riskier, corporate bonds, corporate shares, shares in start-ups and their ilk, and finally junk. Riskier assets include commodities, then forex, both whose valuation changes with the winds of war, news and other calamities. Making all of these riskier are the various derivatives thereof – usually leveraged and also short-able.
Clearly, the further you are from retirement and the more adept you are at reading the market (a function of time, training and a 6th sense few of us really have), the more you can afford to invest in a 400:1 leverage forex future or 30:1 oil CFD. With the increasing regulatory frameworks placed upon these, they are becoming more secure and viable, and every boost helps the final count. Indeed, if you are in your thirties with some spare cash on hand, there’s no reason not to use it – just make sure you 1) withdraw your earnings and place them in your retirement fund, and 2) don’t use you retirement fund equity to pay for your gambling – this should be a one-way street!
But for the basics, one should probably look into the burgeoning Retirement Income Generating (RIG) tools – quite often assets or funds that are invested in high-yield real-estate, Deferred Income Annuities and a host of ETFs, some which are constructed around various risk levelled assets. Still, the risk here is investing in a mutual fund or ETF as a means of avoiding homework. Don’t. Investigate the assets that fund is invested in and its average return rate.
It’s your money and your future. It should be your diligence!