Monday, May 30, 2011

Sancho Panza on Social Security and similar private sectorplans

Sancho Panza, the illiterate but clever and witty sidekick of Don Quixote, has a few comments and questions about our Social Security and related programs.
We call it Social Security Insurance, but it doesn't insure.
We call the payments into the program "contributions", but they sure look like taxes.
We talk about funding, but there's no fund.

We talk about earned benefits, but from whom did we earn them, if not ourselves?
So why do have Social Security Insurance anyway, and more importantly, why do we call it what it isn't?
Why don't individuals simply contribute to their own 401k or IRA and skip the entire Social Security complexity? In other words, why not allow an opt out feature?
But if I'm not permitted to opt out and am required to pay taxes into Social Security by my elected political representatives, for whatever reason, good or bad, why can't I get some clear and simple explanation as to why it is good for me, or if it's not good for me individually, then what portion of my "contributions" go to help my fellow citizens, and why it's good for them and our country, too?
Let's now briefly compare the main features of Social Security and private sector pension plans.
Private sector pension plans are funded on an ongoing basis and have clear and explicit actuarial assumptions about how much the periodically funded amounts are expected to earn over time, thus creating an available pool of money which can be used at old age to pay retirees monthly benefits until death. Annuities offered by insurance companies follow the same formula. The benefits are defined. Hence, we call them defined benefits plans. The corporate sponsor or insurance company, as the case may be, assumes the risk of having adequate growth in the fund to provide the benefits promised to the plan participants.

With respect to public pensions for public employees and Social Security recipients, the taxpayer takes 100% of the underfunding or investment risk that monies won't be sufficient to pay the promised benefits upon retirement. The individual benefit is guaranteed by the taxpayer regardless of the fund's investment return or funding amounts over time. The taxpayer is the guarantor.
Let's now contrast these defined benefit plans with defined contribution plans, commonly (but not exclusively) found in the private sector. In these plans, the contributions are made, but the expected benefits aren't guaranteed or even promised. Not by anyone.

An IRA or 401k is an example of such a "defined contribution" plan. An amount is paid into an individual's account from time to time (by either the plan sponsor, the individual or by both) and then is invested at the direction of the individual over time. The investment risk is borne completely by the individual participant, since only the contribution is defined. Investment results over time are added to the periodic contributions and then paid out at old age until death or until the money runs out, whichever first occurs.
In essence, unlike defined contribution plans, the Social Security defined benefit for current retirees is to be guaranteed by a future generation of taxpayers through their "forced or taxed contributions". The prior generations also gave themselves an out to not fully fund their future benefits at the time they voted themselves those guarantees. While they made "contributions" during their working lives, they could therefore be unconcerned about what happened to those payments after they were made. That's because their benefits were to be guaranteed by future taxpayers. That's our Social Security "insurnce" program.

We the people tend to look at the social security benefits as something we have earned and which becomes our entitlement or right, even though its payment is entirely dependent upon the willingness and ability of future taxpayers to make good on what prior generations have voted for themselves. Simply put, the old folks create rights or entitlements for themselves when they are young and at the same time create responsibilities for the future generations to make good on those rights through the payment of required future taxes to fund the guaranteed benefits.

Pancho doesn't understand either the fairness or the logic of that. Neither do I.

Defined contribution plans, to repeat, confer no such guaranteed payment rights.

That's probably why people today are painfully aware of the status of their individual IRA or 401k accounts, while those people with pensions guaranteed by government plans (public employees largely along with Social Security recipients, as examples) need not be so concerned.
Neither does Sancho see either the the fairness of that one. Nor do I.
So Pancho asks, "Why don't we take care of ourselves without government Social Security"? Good question. It would be a simple thing to do if we followed a few simple steps or habits.
Earnings and then saving a portion thereof, or living within our means, is a habit. Investing is a habit which results from the habit of saving.
When we earn, we either spend less than we earn, spend exactly what we earn, or spend more than we earn. Thus, other than the exactly what we earn scenario, we either generate savings or debt. If we save, we then are able to invest those savings.

As we save and invest, we have an opportunity to learn about the wonderful world of compound interest, the rule of 72 (which will be discussed in a later note) and a secure financial future for ourselves and our family.

If instead of saving and investing a portion of our earnings we choose to borrow, we will have to make interest payments on the debt incurred, and we will then have to begin to save more than we spend if we ever hope to repay that debt. Otherwise the horrible world of compounding will apply to the debt we've assumed.
We have to stop digging the hole of accumulated debt, in other words, if we ever want to get out of the hole we're digging and enter the world of saving and investing. It's harder this way, but it's also better late than never.
This compounding from savings joy or borrowing sorrow all starts for each of us at a relatively early age. Student loans, credit cards, car loans, home loans and many other loans are all out there for the taking. And they are habit forming as well, just like saving and investing are.
Sancho wonders if "We the People" and our government are ready, eager and willing to learn about hole digging, changing our deeply entrenched habits about debt and then following all this up by acquiring the joys of compound interest. So do I.
But he hopes we are. So do I.

Thanks. Bob.

Thursday, May 26, 2011

Pogo's simple truth as amended by the Constitution

Pogo, one of my favorite comic strip characters of long ago, famously said that "We have met the enemy and he is us." Sounds right to me, especially if we begin the snetence with the first three words in the Preamble to the Constitution.
As amended Pogo's simple truth would read "We the People have met the enemy and he is us.
Our own individual financial situation is known, or should be known, in some detail to each of us. We have no debt, some debt, too much debt, no income, some income, no savings, some savings, no expenses, some expenses, no hope, some hope and so forth.
We also know that we can't save or invest for the future if we spend more than we make in the present. And that if we do save or invest, the decision about how early, how much, how often, and what to invest in are all critical.
And that if instead of saving and investing, we spend more than we make, someone has to loan us the money to do so. And if someone does loan us money, that someone expects to be repaid and to also receive a fair rate of interest during the time the loan is outstanding.
That's just simple math. And simple common sense as well.

The same applies to the financial affairs of our country's local, state and federal governments.
In that regard, "WE THE PEOPLE" have spent many decades getting into a financial mess. Debts are at record highs and annual deficits continue to grow while the economy stagnates. That's pretty much universally acknowledged. Something has to be done to change all this by "We the People".
So what kind of change needs to happen when we face our current ugly reality .... at what some believe is a point of seemingly no hope for future generations? (A recent survey of Americans reports that 50% of Americans believe that our country will go broke before we reach a balanced budget. Needless to say, they survey didn't report when we would begin to repay the trillions of debt already owed.)
In other words, what are we to do when debt and deficits have reached levels which are clearly unsustainable? Simply, we as a society must reduce expenditures, increase income or invoke some combination thereof in order to stop the deficits and begin to pay back the excessive debt and interest charges we're incurring. Most importantly, we must enable sustainable economic growth in the coming years and decades.

{So if it's so simple, why is it that the process hasn't already happened? Because in large part, I would argue, "We the People" have for far too long engaged in a combination of what economists label as rational ignorance and rational irrationality. Simply put, rational ignorance means that we don't invest the time to become informed citizens on these matters and instead defer to our elected representatives. One vote won't affect the general election outcome, we choose to do other things with our limited time than be informed about our economic reality as a country.
Similarly, rational irrationality means that it's rational for us as individuals to act in a manner which may make us "feel good" but is contrary to the general good of our society. We thus enable our elected officials to make commitments and spend money we don't have in order to do favors for those constituents and factions which seek them. The public employee unions and the elderly are perhaps the best example of this "feel good" effort. Again, the thought is that it doesn't affect us, at least in the very short term, so why bother?
Since "We the People" don't take the time to know what's going on in the larger sense, (rational ignorance and rational irrationality), the politician commits us by granting special, albeit mostly unfunded, favors to selected parties, and the general economic situation deteriorates. In the short run, we may "feel good", but in the longer term, we end up where rational people acting rationally knew we would. Enacting legislation which helps certain people but for which we don't pay doesn't serve our society well at all.

So what do We the People do now? First, as individuals we stop acting in a rationally ignorant and irrational manner with respect to both our government and, and where the shoe fits, in our personal affairs as well. Second, we face the fact that the next thirty years won't look anything like the last thirty years. In this regard, things like housing, employment, investments ("financial repression" is a concept that needs to be broadly understood, for example), entitlements for the elderly, the costs of public education, national security and so forth must all be on the table for consideration.
But to have an ongoing serious and adult conversation about these things, we must do our part to change the existing culture. That's due to the fact that, as Pogo said, we the people are now our own enemy. Therefore, we also are the solution to the problem. It's that simple and that hard, too.
And why do we each need to play a part in changing the culture? Because it's our country.
With respect to changing the culture, John Kotter's eight steps ("Leading Change" book of 1995 or google/bing Kotter's 8 steps) of the transformational change process come to mind. We begin by (1) Creating a sense of urgency, (2) building a coalition, (3) creating a vision of what needs to be done, (4) communicating that vision, (5) having small successes, (6) building on those successes, (7) overcoming obstacles and (8) finally, the culture changes. In other words, lasting cultural change comes last and not first.
While fully realizing that I may be, although unintentionally, playing the role of windmill tilting Don Quixote here, I'm looking for fellow Quixotes ..... concerned citizens .... to commit to becoming better informed citizens and volunteering, with a sense of urgency, to join the coaliton of the willing. It's critical to our vision of a free and secure people operating in a market based society, thus passing on the American dream and promise to our children and grandchildren.

So here goes.
Today as a country we have more debt than we have plans to repay during the next several decades at least. In fact, we have exactly zero plans to repay any debt, and plan to spend more than we take in for the indefinite future. That's an untenable situation. Government induced "financial repression" lies ahead, meaning negative real andn nominally higher interest rates as far as the eye can see. That has serious implications for all of us, and especially for savers and investors, as well as for borrowers.

In the final analysis, this will come down to sustainable economic growth. Sustainable economic growth comes from free people participating in a market based economy. The bigger the role of government, the less freedom for both the people and the economy.
So we'll argue for a smaller role for government. More freedom for the people.
And a bigger dose of self reliance for individuals and families.
And a deeper understanding of what being an American means with respect to our responsibilities as well as our rights.
And we'll make the case for informed citizens acquiring more knowledge about how our people, our government and our society works best.
We'll deal with all these issues and hope to get input from our fellow citizens along the way to building a better America through knowledge, involvement and understanding.
To repeat, Pogo said it best, "We have met the enemy and he is us."
Thanks. Bob.

Wednesday, May 25, 2011


I wonder if youth is too young to focus on savings and such. If so, the problem presented by the near retirees herein is essentially insoluble. If not, it's rather easily avoided and/or remedied with some simple education about spending, investing and such.

Any thoughts about whether there's a market for a legitimate and other than hand holding/wringing offering to the underserved and the scared and cynical already out there among the oldsters?

Andrea Coombes' Ways and Means
Don’t let fear ruin your retirement

Many decades of relevant European experience teaches that we can't have both.

BUSINESS DAY | September 29, 2010
Economix: Look to Europe to Understand Why This U.S. Recovery Is Jobless
If the United States expands its social safety net, Americans might enjoy some of the European lifestyle, or recover the jobs lost during this recession, but not both, an economist writes.

This is the type of information and belief that should be shared with young people everywhere. Even the NBA types. - Money Lessons for Every High-School Graduate* This article will be available to non-subscribers of the Online Journal for up to seven days after it is e-mailed.

*This article can also be accessed if you copy and paste the entire address below into your web browser.