Are workers saving enough?
As we emphasized in a 2014 Mathematical Investor blog, individual investors are not very well equipped, and certainly not very effective, in managing their own investment savings. They chronically fail to save enough, and very often mismanage what they do save.
This is unfortunate, because fewer workers than in the past, particularly in the U.S., are covered by a “defined-benefit” retirement system (pension). Instead, a growing fraction of workers rely on 401(k) systems or the equivalent, where they optionally contribute to an investment fund that they have either partial or full discretion to manage. More than any generation before, the present generation of workers will be personally responsible for their future financial well-being.
Other nations are facing similar challenges. In Canada, for instance, their social security system provides only about half what it does in the U.S. In Australia, large employers such as universities typically place roughly 17% of a worker’s income into a “superannuation fund.” In Canada, pension savings are taxed as they are withdrawn, whereas in Australia superannuation funds are not taxed provided they are withdrawn as annuities. In continental Europe, mandatory retirement rules still exist, while in the English-speaking world, such rules, mercifully, are largely a thing of the past.
How well are today’s workers doing in saving for retirement and managing their savings? Sadly, according to the latest figures from the Social Security Administration, 50% of married retirees and 71% of single retirees rely on Social Security for more than half of their total income. Further, 23% of married retirees and 43% of unmarried retirees rely on Social Security for at least 90% of their income. Among current workers, 39% of current workers have not saved any money for retirement; among workers in their fifties, the median retirement savings is only $117,000, which means that when they retire they can rely only on less than $5,000 per year of income (assuming a 4% annual drawdown; some analysts say that even 4% amount is too much).
As a result, many new retirees face the painful choice of either accepting a severe drop in living standards, prematurely exhausting savings and being at the mercy of children or relatives, or, as a recent Washington Post article describes, joining the growing army of “workampers,” who have sold their remaining assets and travel around the U.S. in RVs in search of temporary or part-time work. Some of these find work at Walmart or Amazon centers during the Christmas rush. But such work is often temporary and seasonal, after which workers must move on.
How well equipped are workers to manage their own retirement savings?
Of equal concern is the level of skill with which most individual investors manage their nest eggs. Each year the DALBAR organization releases a report known as the Quantitative Analysis of Investor Behavior, which attempts to measure short- and long-term performance of individual investors’ savings. The 2017 DALBAR report notes that, over 30-year period ending 31 December 2016:
- Equity fund (stock) investors averaged only 3.98% annualized return, compared with 10.16% return from the S&P500 (including reinvested dividends).
- Fixed income (bond) fund investors did even more poorly — an abysmal 0.57%, compared with 6.34% for the Barclay Aggregate Bond Index.
For the 12-month period ending 31 December 2016, the statistics showed little improvement from these depressing results:
- Equity fund investors averaged 7.26% return for the year, versus 11.96% return for the S&P500.
- Fixed income fund investors averaged 1.23%, versus 2.65% for the Barclay Aggregate Bond Index.
The DALBAR report also summarizes the principal reasons for poor performance. One is a lack of patience:
The retention rate data for equity, fixed-income and asset-allocation mutual funds strongly suggests that investors lack the patience and long-term vision to stay invested in any one fund for much more than four years. Jumping into and out of investments every few years is not a prudent strategy because investors are simply unable to correctly time when to make such moves.
Other behavioral failings include loss aversion (panic selling at the worst possible time), lack of diversification, following the herd and media attention (i.e., buying when everyone else is) and excessive optimism in one’s chosen strategy.
A sad story that never ends
The depressing facts above seem to never change — savers don’t save anywhere enough, and investments they do make consistently underperform market averages. As MarketWatch commentator Paul Merriman observes:
Every year the conclusion [of the DALBAR report] is the same: On average, investors earn less than mutual fund performance figures imply. Sometimes they earn much less. … One conclusion: No matter whether the market is booming or busting, “Investor results are more dependent on investor behavior than on fund performance.” Investors who buy and hang on are consistently more successful than those who move in and out of the markets.
Along this line, market commentator Robert Powell laments that he has had “the most depressing job in America” — writing about retirement savings. In addition to the facts mentioned above, Powell points out how the average American has to deal with “confusing and conflicting” information. The financial services industry has introduced hundreds of new ETFs, reverse mortgages, health savings accounts, Roth IRAs, variable annuities, guaranteed income benefits, guaranteed accumulation benefits, deferred income annuities, hybrid insurance-annuity packages and more. How can a typical middle-class worker or retiree possibly be expected to navigate this maze?
For example, as we reported in a previous blog, even the simple question of when to start receiving Social Security payments can be quite tricky, requiring access to special computer software to make the best decision. Also, the supposedly simple matter of dispersing IRA funds at a person’s death can be very complicated, depending on circumstances.
What can be done?
A straightforward conclusion of studies in evolutionary biology is that the human mind will discount future benefits, such as savings and investment, in favor of near-term benefits (a person might not survive many years into the future, so why defer?). So encouraging retirement savings is, to a certain extent, fighting human nature. And, regrettably, human nature also leads people to overestimate their skill in managing investments. Better one-on-one advice to overcome this destructive cycle would help, but surely there are other measures that can be taken at the government level as well.
Louis S. Harvey, President of DALBAR, writes:
It is now past the time for the investment community and its regulators to understand that the principle of educating uninterested investors about the complexities of investing is unproductive. … We need a fundamental change that transforms investment thinking into meaningful decisions and choices for retail investors.
Richard Thaler received the 2017 Nobel Prize in economics. His specialty is behavioral economics, exploring the obvious if unpleasant fact that humans are not always perfectly rational economic actors. Among other things, Thaler has advocated the usage of various “nudges” to encourage people to do what is in their own and society’s best interests.
Thaler has long advocated that 401(k) contributions, for instance, be offered on an automatic enrollment basis when one starts employment (but with the option to opt out if needed in the future), and then automatically increase in level until they reach some pre-set maximum. Partly due to Thaler’s influence, in 2006 the U.S. Congress passed a law “encouraging” firms to implement automatic enrollment and automatic escalation in 401(k) retirement savings plans. Benartzi and Thaler estimate that as a result of this law, total savings had increased by $7.6 billion by 2013. The U.K. recently launched a similar national savings plan with automatic enrollment, with 88% participation.
The next step is clear — Congress needs to pass a measure requiring automatic enrollment and escalation. But encouraging more retirement savings is not enough — workers (and retirees) also need simple, no-nonsense advice, and a choice of some solid, rational investment programs. Either way, we cannot merely say “buyer beware” and trust the system to work for everyone.
[23 Oct 2017: The DALBAR statistics above were updated for the 2017 report.]