For those of you who read the headline and now have your britches in a wad, let me start by saying, notice I didn’t call the President childish but one of his ideas. Don’t get upset yet. Read on to understand.
In any debate, it is appropriate to begin by defining the terms to be used. Allow me a moment to define a few terms before I make my argument. Saving is something that one does over a short time frame. The goal may be to buy something in the future or to put money aside for an emergency. When saving is done long term, I prefer using the term investing. Saving is for less than 5 years and investing is for more than 5 years. Saving money implies to me not risking it while accepting low rates of return. Investing implies assuming risk in order to gain a higher return. With those terms defined, let me move on to my point.
In the President’s State of the Union Address last night, he stated, “Let’s do more to help Americans save for retirement. Today, most workers don’t have a pension. A Social Security check often isn’t enough on it’s own. And while the stock market has doubled over the last five years, that doesn’t help folks who don’t have 401ks.” So far, with the exception of one thing, I agree with the President. As I described above, I don’t believe Americans should save but rather need to invest for retirement.
He then proceeded to say that he will direct the Treasury Department to create a “new way for working Americans to start their own retirement savings.” There it is again. Saving for retirement. His plan is to create a new account called MyRA that allows people to purchase government savings bonds to “build a nest egg”. This program, according to the President, would guarantee a “decent return with no risk of losing what you put in”. The plan has been described as being similar to a Roth IRA but employer sponsored like a 401k.
The idea of saving for retirement using an instrument that currently earns a return less than the historical inflation average is not a way to build wealth. Earning 1.7% while inflation reduces the value of your money by 2% per year means you are actually losing .3% of purchasing power each year. Allow me a quick math example. Let’s say you have $1,000 in a savings account earning 1.7%. At the end of the year, your account would have a balance of (1000*1.017) or $1,017. Deflating that amount to determine it’s real value after inflation means those same $1,017 would only buy the equivalent of $997.05 worth of goods at the beginning of the year. As one can see, although you made $17 in nominal terms (before adjusting for inflation), you actually lost $2.95 in real terms (adjusted for inflation).
Instead of starting a new program for working Americans, why not make enrolling in 401k programs an automatic action when one is first employed. Employers would automatically enroll new hires and have a 5% contribution made from their salary. The employee would have to opt out of the program. When left up to the employee, most would never choose to enroll. This would get more working Americans into our capital markets thus allowing them the opportunity to earn a greater return. Since employees can’t retire until age 59 1/2, most would be investing for the long term. When leaving a company, the money should be required to roll over into a corresponding IRA. If you have a Roth 401k, the money goes into a Roth IRA; those with a normal 401k would roll into a regular IRA. This would get more people investing and earn them a return that is greater than inflation thus building long-term wealth.
Now, why is the President’s idea childish. The program he is advocating would be a wonderful program to offer children. It would teach them the value of saving. Learning to save is a prerequisite to learning to invest for retirement. This program would be similar to the war and thrift savings stamps offered by the government during the early 20th century. These stamps were marketed towards children. In fact, kids were largely responsible for helping sell the stamps. I would love to see a program like the MyRA program marketed to kids where they would be encouraged to save. Once enough money was in the account, the fund would automatically redeem the bonds for a share in an S&P 500 Index Fund. That way kids learn the importance of saving but over time their money would grow at market rates. The money and shares would stay in their account until they turn 18 at which point the account would convert to a Roth IRA. By this time, they hopefully would have a better understanding of mutual funds and investing. The important point is the money would be in their account at a very early age, leaving plenty of time for the account to grow to a very large amount. Thus, these young future working Americans would not have to rely on Social Security.
Let’s get working Americans investing for retirement while teaching kids to save in a way that converts to investing. The program the President outlined is better suited for the latter. See, that criticism wasn’t so bad was it?