Saturday, January 10, 2009

“Broken” Record

A few decades ago, I suffered a nasty skiing accident. I was “bored” (the course was, overall, beneath even my modest skill levels), it was late in the afternoon, and—as humans are sometimes wont to do—I found myself trying to make the course more challenging by doing something stupid. Actually, by doing something stupid three times (which, by some definition, is doing something really stupid)—when “fate” intervened and kept me from breaking my neck…by breaking my leg.

It was a difficult lesson to learn (more accurately, it was a difficult way to learn the lesson); I spent the next six months in the middle of a Chicago winter in a cast—much of it in a cast that encased my entire leg, which also happened to be the leg you need to drive.

I learned a lot as a result of that experience—but one thing that never, even for a second, occurred to me was to blame the icy slope, the skis, or the tree I slammed into, though all surely played a significant role in the final result (…perhaps if I had been a lawyer, rather than a law student, at the time…).

Failing “Grades”

There’s been a lot of press devoted lately to the “failure” of the 401(k)—even though, IMHO, like my skis, it hasn’t done anything other than perform as advertised: In fact, it has provided millions of working Americans with a wonderful opportunity and incentive to provide for their own financial future.

It is, of course, that very opportunity that makes the current economic “crisis” so much more painful. Even those Americans not in fear of losing their jobs feel poorer—feel, and rightly so, IMHO, that they have been robbed.

However, it is not the 401(k) that has robbed them. Their 401(k), in a crude analogy, is no more at fault than were my skis (though there were surely some who, like I, were taking foolish risks late in the day). The real culprits are to be found in greedy mortgage lenders, pliable mortgage takers, opportunistic securitizers, and a facilitative government (see “IMHO: Pay “Back”?” ). And, as painful as those losses surely have been, and however much money has been lost in an individual account, I’m pretty sure no one has yet lost everything they ever put in, much less the “cushion” of the employer match. Compare that with Social Security—will you ever get back what was taken from your pay over a lifetime of working (odds are, you’ll also pay taxes on money that has already been taxed)? Let’s face it: Social Security isn’t immune from the economy, or the markets—it’s just that the problem seems like someone else’s to fix (and we know how they’ll fix it, sooner or later).

Let’s be frank: The 401(k) has provided millions of Americans with their first—and only—education about the markets and concepts like tax deferral and the value of compound interest. It has provided an interim source of funds in times of financial stress, and it has provided many with their first—and only—opportunity to invest in our great capital markets. Indeed, each and every 401(k) balance literally represents a conscious decision to forgo compensation in the here-and-now for the security it can (and must) provide in the future. It is a character trait and discipline that Americans are said to lack—and yet, the 401(k)’s tremendous success puts the lie to that conclusion.

Its benefits to the most highly compensated are negligible, barely enough to sustain their ongoing commitment to sponsoring these programs, while it offers those of more modest means a convenient, efficient way to take responsibility for their own financial future.

The bottom line is that, IMHO, the 401(k) has been a marvelous success: It’s a venue where millions of Americans who save nowhere else—and who would save nowhere else—choose to do so, and they do so because it is a system that encourages and nurtures that behavior—both financially and via education.

It is not the only answer to true financial security in retirement—but then, it was never meant to be.

—Nevin E. Adams, JD


  1. Mr. Nevin,
    You are 100% correct when stating that the 401K has been a huge success. It's been wildly successful for TPAs, insurance companies, mutual funds, broker-dealers, investment advisers, Attorneys, and Trade organizations. Truly an unprecedented big win for those who earn a living from the industry. Participants however have been mostly let down by complex, opaque, and expensive plans & products, chosen by employers who all too easily forget they're spending their employees (tax-deferred) income. The 401K is a brilliant concept that has been in most cases poorly executed. Maybe we've made a turn with the recent financial meltdown but I'm not that hopeful.

  2. No doubt the 401(k) - like any good business - had generated a good living for those who build and support it. Doubtless there are those who have profited from it in ways they should not have...surely there are those who have taken advantage of the ignorance of those they purport to serve. But that, in my 30 years of experience in this business, is not the reality in the vast majority of cases.

    It is, however, a precept that those who would like to cut the participant out from the protections of that system (and there are protections) - or who would like to impose some kind of uber-Social Security program on the nation's workforce - are fond of recounting.

    Thanks for your comments.

  3. Nevin, I was struck by the comparison of your "Broken Record" Page 6 article of the February 2009 issue compared to Fred Reish's article on page 64 on "Re-Inventing 401(k) Plans as Retirement Plans.

    Anyway, as Dr. Ghilarducci proposes and Mr. Reish confirms, her concept delivers "... 100% coverage, 70% average income replacement in retirement (together with Social Security), relatively low expenses, and no investment responsibility for employers."

    Seems to me that proposals by Mr. Reish and Dr. Ghilarducci should be limited to actions that incorporate no new taxpayer spend or guarantees. Aren't we facing a major entitlement challenge today - $101 Trillion of unfunded liability (using the indefinite estimate)?

    As you say, "... Social Security isn't immune from the economy or the markets - it's just that the prioblem seems like someone else's to fix (and we know how they'll fix it, sooner, or later).

    We cannot just let individuals assert such a change is doable without estimating the impact of a completely new entitlement - a 3% real rate of return, guaranteed, on savings.

    Finally, if Dr. Ghilarducci and Mr. Reish want a pilot experiment, have them start with today's Social Security. When they can guarantee a 3% real rate of return on my already after-tax contributions with no taxpayer "match", perhaps they will have earned a second chance to experiment with my savings. You say it better on page 6 "... Compare that with Social Security - will you ever get back what was taken from your pay over a lifetime of working..."

  4. Nevin,

    One other comment. I found a very recent release from the Center for Retirement Research at Boston College, February 2009, Number 9.4, where Dr. Alicia Munnell and others have an article titled: "What Does It Cost to Guarantee Returns". The brief if a speculative discussion of what might be involved if a new tier of retirement saving were introduced with the goal of minimizing large variations in replacement rates.

    Interesting reading. Conclusions:
    (1) Volatility is inevitable when outcomes are left completely up to the market,
    (2) In the past, hindsight (which is 20-20) tells us that guarantees would have been cheap,
    (3) Prospectively, guarantees in excess of the risk-free rate are not possible if the guarantor shares the market's aversion to risk, and
    (4) As long as the guarantor shares the market's aversion to risk, rate of return guarantes are unlikely to solve the problem of wide variations in outcomes due to market fluctuations.

  5. Did you see recent study from Boston Center For Retirement Research on cost of a guaranteed rate of return? Interesting reading.