Broken Promises: The Baby Boomer's Lament
By Tony Allison, April 16, 2007
“How do we get around the promise that was made when people got into Social Security? How do you suggest that we tell the American people?”
Senator Jim Bunning posed these questions to Federal Reserve Chairman Ben Bernanke during his Senate testimony in January of this year. Mr. Bernanke had no real answer, because there is no “happy” answer. The promises that were made for both Social Security and Medicare will not be kept for the Baby Boom generation, at least not with dollars that have any buying power.
Boomers Must Rely on Themselves
This is just part of the daunting landscape facing the 76 million-strong Baby Boomer generation as it begins to retire. The whole concept of retirement in America has changed and will continue to change. In the decades prior to the 1980’s, people tended to stay with one company for their whole career, and retire with a deferred benefit pension plan which provided them a certain percentage of their salary for life. Today, the burden has been pushed onto the shoulders of the retiring workers through the 401-k and IRA programs. Most future retirees will have to rely on their 401-k, IRA’s and a meager Social Security stipend to survive a very long retirement in many cases. Unlike the prior generation, most have no idea whether their retirement will end well or badly. Life will be much more uncertain for retirees in the future.
A series of increases in FICA and Medicare taxes over the past 25 years was supposed to secure the retirement system for future generations. Unfortunately, those surplus funds that flowed into the system have all been spent, replaced with paper IOU’s worth less than the cost of the paper. Future retirees should understand that they can’t count on Social Security. It will be inflated and means-tested into oblivion. And later qualifying ages are already a reality.
The key point is that for those retiring in the next decade and beyond, the individual is going to be more and more responsible for providing for his/her well being in retirement. Your greatest security will ultimately come from how much you save, how well you invest, and how well you manage your own assets. This is not the message the average Baby Boomer wants to hear, but it is the reality of America in the 21st century.
Losing Purchasing Power
The retiree also faces the dilemma of how to allocate the resources once in retirement. Many retirement planners suggest a ratio of 50-70% fixed income, i.e., bonds or bond funds. That may have worked in the 1980’s with unprecedented sky-high interest rates, but rates are now much lower, and inflation is higher than government statistics suggest. After paying taxes and adjusting for real life inflation (7-10%), the retiree on a fixed income is losing purchasing power every year. As inflation continues, the fixed income grows ever smaller in real terms. And don’t expect much tax relief in the future.
Those who are already retired become trapped in a vicious spiral of declining living standards. If inflation heats up into double digits, the spiral just spins faster, and causes the value of the bonds to drop further, making it very difficult psychologically to sell a large part of one’s nest egg at a loss to reposition the funds.
No one ever said growing old would be a picnic. But having some understanding of the pervasive level of inflation in the economy, and the potential for a lot more, will allow investors to be prepared for it, and at least partially mitigate its effects.
One of the ways to hedge against inflation is through stock dividend investing. This may seem an obvious plan, but many people look at fixed income as safer, more reliable and guaranteed. That may all be true, but the overlying problem is the “fixed” part. The fixed income won’t grow, and inflation will eat away at the real return every year.
Conversely, if you choose a diversified selection of solid, mature companies with a long history of growing dividend payouts, you have a fighting chance. If a retiree has income from dividends of $25,000 in the first year of retirement, the next year it will likely be $27,000, and perhaps even higher. In the words of Professor Jeremy Siegel, “The power of the basic principle of investor return is magnified when the stock pays a dividend.”
Due to the risk of a much lower US dollar in future years, it may be wise to include foreign blue chip companies in the mix, as well as US multinationals that derive significant earnings from overseas sales. Emphasize industries that have performed the best over time in terms of consistent dividend growth, including brand-name consumer staples, pharmaceuticals, and energy stocks. Dividend investing is of course just one method for hedging one’s retirement portfolio against inflation. I will focus on other strategies in future articles.
US Dollar vs. Euro
The Cost of Survival
As the cost of the basics for survival continues to rise, the retiree’s income must rise at the same rate. How do you think the government with $50 trillion (and rising rapidly) in unfunded Social Security and Medicare liabilities will pay those bills? Means testing is inevitable, but it won’t be nearly enough. The only practical solution (for the government) is to print the money and inflate the currency. You begin to get the idea of what will happen to those on a pension or invested exclusively in annuities and bond funds.
Saving and budgeting are still very important elements for those in retirement or planning to retire. But how you strategically build a retirement portfolio is even more important. The CPI has been down in just 2 of the last 60 years, and that included many years when the government ran trade surpluses and wasn’t buried in debt. The bottom line is medical care, food, travel, insurance, energy, etc. will cost more a year after retirement, and go up from there.
Grow Your Portfolio during Retirement
There are other risks to retirement of course, including allocation risk, longevity risk, and health care risk. But I believe the most pervasive risk facing retired America in future decades will be the risk of inflation wreaking havoc on their quality of life. The ability to grow one’s portfolio during retirement, both in terms of income and principal, will be critical. It may just be the difference between a comfortable life and life on the edge. Status quo vs. Alpo. That may sound harsh, but a debased currency always inflicts the most pain on those with the fewest resources, and no ability to hedge the inflation. See Weimar Germany in the 1920’s and Argentina in the late 1990’s.
My focus tends to be on the big picture issues, especially those concerning the Baby Boomers. Perhaps this is because I’m one of the 76 million. But the fact is that this is the largest demographic group in the history of our Republic (nearly 40% of the population over age 18), rocketing toward retirement like an unguided missile, with unknown but significant consequences upon arrival.
Everyone’s needs, goals and dreams are different in retirement. But no matter how frugal or how financially secure, everyone needs to protect their purchasing power. Don’t settle for a cookie cutter approach. Do your homework. Find the plan that works best for you. Don’t be seduced by easy answers. An inflationary future requires recognition of the situation, and proactive planning. This means saving and investing wisely, well in advance of retirement. Anything less is living in denial, which in this case is definitely not a river in Egypt.
The Dow Jones Industrial Average rose 108.33, or 0.86 percent, to 12,720.46. The Dow's increase Monday put the blue chip average back above where it stood before the major U.S. indexes fell more than 3 percent on February 27th as part of a worldwide selloff. The Dow is within 66 points of its all-time closing high of 12,786.64, reached February 20th.
The broader stock indicators were up as well. The S&P 500 index rose 15.62, or 1.08 percent, to 1,468.47, a six-and-a-half-year high. The Nasdaq composite index rose 26.39, or 1.06 percent, to 2,518.33.
Bonds advanced, with the yield on the benchmark 10-year Treasury note falling to 4.74 percent from 4.77 percent late Friday. The dollar traded near all-time lows versus the euro, and was mostly lower against other major currencies.
Oil prices fell Monday, with a barrel of light sweet crude settling down 2 cents at $63.61 on the New York Mercantile Exchange.
Wishing you a good evening and a prosperous retirement.
© 2007 Tony Allsion