Say what you will about trust in the free market, but the simple fact is many people lost up to 20% on their 401k's with this crash. Imagine if social security had been privatized. 401k's open individual employees to the systemic risks of investing in the market. This is especially dangerous when your average employee at any given job is uninformed about how to even manage investments. Plus, those who couldn't get loans before (and many who can't get loans now) are dipping into their 401k's just to pay off debt. What do we say to them? Tough luck?
I'm not arguing for nationalization, I still don't think it's coming. But it is pretty clear that, like Social Security, something has to be done because there is just no money to sustain 401k's.
The now infamous Teresa Ghilarducci, the professor who is testifying before Congress, calculated a possible scenario for those with $100,000 in their 401ks:
"She calculated what you would end up with in 10 years if you had $100,000 in your account in August and lost 20 percent of it last month. If you were paying 2 percent in administration fees — as many 401(k) plans charge — and the stock market remained flat for three years — a real possibility given how it has performed — and then earned 1 percent per year — as it did in the 1970s — you would have $67,000 by the end of the decade, she said." “With a flat market at best and high fees, it is likely they will have less than they and their employer put in,” she said.
I think I'm going to start putting some money under my mattress...
~JSK
p.s. - This is in no way a concession of my previously (and currently) held beliefs that Congress will not nationalize 401k's and that fear of such action is premature.
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It appears this topic just won't die, but I'll still indulge. The argument that 401ks are "failing" is ludicrous. We are in a bear market period, just as we have had before. Stocks by their nature are volatile, and that is why stock investment is very risky in the short run. But this volatility is why investors on average achieve high rates of return (8 percent inflation adjusted) in the long run compared to binds (3 percent) and why long term, diversified investment (like in 401ks) is very safe. As I love charts, I point your attention to the one below, which shows the cumulative, inflation adjusted value of a $1,ooo dollar investment in 1962 thought 2007 (this was the last year of annual data), which is approximately the time that one works in his or her career (45 years). But even add roughly a 20% drop for 2008, and you would still be better off.
There has never been a 20 year period in which the stock market was lower at the end of it compared to the beginning, including the Great Depression. To illustrate my point even further, I included a 1 percent annual stock account fee and a 0 percent bond account fee (in reality, bonds have fees as well, and any government run program will also have costs). The professor's 2 percent fee example is high; the average is closer to 1%. But even with 2 percent, stocks still outperform bonds. Furthermore, many of these fees are under the control of the participant based on what funds they buy and whether they want paper or electronic statements or other options they can chose from.
But this kind of analysis, that the professor gives, of being a lump sum over a period of time is deceiving, because this isn't even how these accounts work. First, you don't place a lump sum; you buy regular increments over a period of time so that you employ what is called dollar cost averaging. This means you buy some shares when they are low, some when they are high and over time, this smooths out the performance and makes it less volatile. The even bigger fallacy in her argument is that she cherry picked a period to begin the drop and then took a historical period that happened to be bad as assumed this to be the norm. In reality, if you only had ten years left before retirement (how her example implies), then you likely wouldn't have all stocks anyway. Every personal investment adviser will tell you that when your young and have time to wait, you buy more stocks in your retirement accounts, but as you get older you buy more bonds for your accounts because you cant afford to risk the drop off. They even have time adjusted accounts now that automatically adjust this for you so you don't have to manage it yourself.
Now yes, you could ignore this advise and keep all stocks, but you are given "options" with 401ks which JSK described in a recent post and seems to agree is superior then not having options. This is the real reason why certain people dislike these accounts. Any time people are given freedom to chose their behavior, there is going to be an inequality of results. Some people will take the better advise, and some know how to manage investment better. A government run program, even if its returns are far worse makes it "fair" by forcing equality of being on everyone.
But lets go with the professor's very flawed example for a moment. Lets assume we'll now have another 1970s period. Well why did the 70's stock market act the way it did? Well quite the opposite of being the "free market" it was because government monetary and fiscal policy destroyed the stock market. Operating under the now
proven false premise of the Phillip's Curve, the Federal Reserve inflated the money supply drastically causing the heavy inflation of that period. Now mix this with a much higher nominal capital gains tax rate in the 70's, which in turn is not adjusted for inflation, and the result is an average inflation adjusted capital gains tax of between 80 percent and 150 percent over this period! No wonder the stock market didn't perform well. If the government is going to take your entire gain, why would one invest? For more on this you can read this.As long as we don't employ these similar policies again, the stock market should not have a similar long run behavior. Now maybe government will and then we can argue for the professor's plan, but that sounds similar to arguing that the remedy for taking a daily dose of poison is to take the counter medication. Well why not just stop taking the poison in the first place?
Though not by design, the 70's era stock market was a living example of how Lenin described how the bourgeoisie (those who own capital, ie stocks) could be destroyed, "the way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation."
If we decide to learn from our past, a similar scenario will not occur.
-EJB
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I'm not going to defend the Professor's work, because I really don't know enough about the details and mechanisms of this process. I'll leave it up to the readers to do their own research and come to their own conclusions about whether to believe EJB or not. But I will point out one thing which sticks out as a fundamental philosophical point.
EJB says:
Now yes, you could ignore this advise and keep all stocks, but you are given "options" with 401ks which JSK described in a recent post and seems to agree is superior then not having options. This is the real reason why certain people dislike these accounts. Any time people are given freedom to chose their behavior, there is going to be an inequality of results. Some people will take the better advise, and some know how to manage investment better. A government run program, even if its returns are far worse makes it "fair" by forcing equality of being on everyone.
First of all, returns from government-run programs are only "far worse" if you actually receive and follow good advice regarding your 401k. Because your 401k is subject to the volatility and systemic risk inherent in the market, there is absolutely no guarantee that you'll make any positive return whatsoever. Some people are just more naturally risk averse than others and it seems to me that there are those who would rather take the government run program because you're guaranteed at least SOMETHING. 401k's, however, are phasing pensions out and this is a problem. EJB is correct to say that I am in favor of options...thus I would say that 401k's should continue to exist, but only as supplements to a pension plan, if the employee so desires.
Another fault with EJBs reasoning here is the idea that people might "ignore" good advice. What this assumes is that they even have access to that advice in the first place, which cannot be assumed. Not all of us enjoy researching market information as much as EJB seems to. Not everyone even has basic access to the means of initiating that research. So it is just not the case that, if your 401k suffers, it's because you "ignored" good advice. Even those who do enjoy access to market advice can fall prey to incompetency, through no fault of their own. To these people, EJB would seem to say 'tough luck.' Suddenly equality, and specifically equality of opportunity, is a vice? Pension plans "force" equality on people?
If this were merely a case about "inequality of results" then I would graciously accept the argument that 401k's are a better means of retirement savings. But this euphemistic language hides the fact that what's really happening here is that the 401k system favors those who already have the means to access competent retirement/market advice. These are the people who need the least help with retirement. It is the menial job workers, those who cannot hire a private investment firm to aid them with their account, that suffer the most when the market tanks. We should not take away their ability to rely on their employers for retirement, like so many did during the time when pensions were standard. 401k's can stay, but they should not wholly replace pension plans.
~JSK
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