I went to what is called an “alternative” or “hippie” high school as a kid. I didn’t take away too much from a school with no grades, where we made our own schedule and called teachers by their first names, but I did manage to keep a few gems I may not have gotten at a traditional high school. One of these is a healthy skepticism of the media and how they interpret things.
This was long before the era of “fake news.” I had a media class for 2 hours a day, 4 days a week where the first hour was spent reading the newspaper. What a life. The next half hour would be spent discussing articles we read, analyzing them and debating their significance. A few things I remember learning was that the media thrives off of sensationalism and that there is no such thing as objective media. What really hit home for me was when the teacher pointed out that no newspaper is objective for the simple fact that someone, likely an editor or an editorial board is choosing which stories they put on the front page or in bold letters at the top. That is always going to be someone’s or some group’s opinion on what they think is important.
I am telling you this because armed with this knowledge I often read articles and like to pear behind the story, examine its sources and arrive at conclusions for myself. Much of the time, I find that the real story is not as dramatic as the headlines make it seem.
The Retirement Scare
Source: CNBC
Take for example this recent article I came across on CNBC. The headline claims that millennials will need to save almost half their paycheck to retire at 65. As someone who often obsesses about my own retirement savings, college savings for my son and post tax savings, I was a bit concerned about this. After all my careful planning, could it be that I was not even saving enough?
Journalists often scour research in order to shorten it, summarize it, draw some sometimes questionable assertions from it and then slap a sensational headline on it to get clicks. The great thing now is the references are there for anyone to click through, which unlike most people, I often do, so I was able to dig deeper into this particular claim.
It’s starts with a reference to work done by Olivia S. Mitchell, a professor of insurance and risk management at the University of Pennsylvania who is also executive director of the Wharton Pension Research Counsel. I would think this is enough to mean she’s no dummy and knows a thing or two on what she is talking about when it comes to retirement.
Using the link provided in the article, I was not able to see the study. I assume that the journalist may have been given an advanced copy of it to help get the word out. No issue with that, other than I can’t see how they get to these numbers. The article did mention that the paper was based off calculations done by James Poterba of MIT, which I was able to see here.
Dr. Poterba’s paper has a section where he discusses a model for the proportion of your salary saved over time in a low return environment. He presented a table of these results and have the simple example of 1% of your salary saved at a 1% return over various periods. The wealth that accumulated at the end of that period as a proportion of your salary is circled in his table below.
Source: NBER
What this means is that someone who saves 1% of their salary at a 1% return can expect to have 30% of their annual income in savings by the time they reach retirement.
I decided to do a simple annual compounding in excel to see if I could get to similar numbers which you can see below.
Source: author’s calculations
The above assumes someone makes $70,000 a year and saves 1% with a 1% return. I assumed all are real values just as the original author did.
What I found with my simple compounding is that I arrived at about 0.348 after 30 years as opposed to 0.30. I am no math wiz but assume this is because the original author’s model uses an integral calculation to arrive at that figure. For our purposes though, it’s in the ballpark.
The Low Return Future
The basis of the headline is that since there has been such great growth in the stock market the last 10 years, we are in for weak returns for the foreseeable future. The stock market has returned about 7%-8% on average after inflation annually. Vanguard predicts that the real rate of return over the next 10 years will likely be under 3%. Those are pretty weak returns which, if they were to hold over another 30 years, would mean that millennials really would have to save a ton to retire at 65. To get an idea of what this would look like I did the same exercise saving 40%, which is what the research claims may be needed, versus a 3% real return over 30 years.
Source: Author’s Calculations
We end up with about $1.3 million which kind of works out very nicely if you go by the run of the mill retirement numbers: a 4% withdrawal rate would be about 75% of the $70k income which should be able to maintain this retiree for many years.
So it could be that the article has a point, that we are all screwed because we are not saving 40% of our pretax income in retirement accounts. Seems like we are all doomed to work until we die. The article even offers working longer as one of the solutions to the issue.
The Holes in the Theory
It’s true that we have had a good 10 years. The decade prior, known as the “lost decade” of investing in the US from 2000 to 2009 saw zero gains in the market. Forget the fact that stocks were way overpriced in 2000 and then we saw a financial crisis in 2008-2009. It’s the sense of hopelessness that people remember.
Source: mybudget360
That decade though was like a hangover after a massive boom that saw GDP grow by a third in the 90’s. This is the constant ebb and flow of the market. The 60’s were great, the 70’s terrible. The 80’s great, then we had a recession in the early 90’s. Then stocks took off with the internet age arriving in the mid to late 90’s.
The fact is, whenever there is reason to be pessimistic, it can last for many years but it doesn’t last forever. Yes equities may be in for a sub par 10 years. However, does that mean they will be in for a subpar 30 years? That’s a bit extreme for me.
Reason for Optimism
If you look back at what has happened in the last 20-30 years, few people would have predicted the turn of events which have either propelled equities or dragged them down at one point or another.
When the dot com bubble burst, who could have predicted that 20 years later, 5 massive tech companies would be propelling the market to new highs? 2 of which had not even been formed yet in the year 2000.
Even though China was starting to liberalize in the early 80’s, who could have predicted that by 2020, the country would be vying for the largest economy in the world and pulling global growth forward along with emerging economies like India.
It’s true that rich country demographics and growth are making for a slow growth picture for the future but money is global and the stage has been set for more countries to add their names to the development story. As I pointed out in my post Investing Long Term With Low Rates: What We Can Learn from Japan the model referenced in the study has not taken into account the potential growth that we may have yet to see in emerging markets. Emerging markets have underperformed since the crisis but don’t forget that they saw a huge run up prior to the crisis and it has been US equities that picked up the high growth model since then. It’s overdue that they trade places and that emerging markets retake the mantle of high growth.
Source: Yahoo Finance
In addition, China, even as the second largest economy, is still considered an “emerging market” in many indexes. If this were to change, especially if China slows over the next year or two, we could see an emerging equity class lead by countries like Nigeria, Vietnam and India. Don’t laugh at these names, people did about China 30 years ago and now everyone is on board.
Conclusion
There is still many reasons to be optimistic about equities, just maybe not US equities for a time. If you are willing to change your perspective to include the wider world outside the US, you may be rewarded by not having to scrounge for half your income over 30 years to retire. There still is a case for growth out there, despite the headlines.
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