Friday, March 29, 2013

PERSONAL PRIORITIES ... Housing, Stocks, Pensions, 401(k)s and Retirement Planning and Preparation

Yogi Berra said that when we come to a fork in the road, we should take it. And Robert Frost in "The Road Not Taken" advises that our choices make all the difference in the world.

And so it is with the choice to borrow and buy a house of our "dreams" early in adulthood or to save and invest in our future financial security.

Actually, the decision need not be an 'either or' choice. We can choose to walk and chew gum at the same time ---- buy a house while we save and invest for the future. And we can do both of these things as long as we think before we act, save before we buy, and at the outset prioritize as financial Job #1 the habit of saving and investing for our future financial security.

But if we only pick one path to follow when we first come to that fork in the road, let's choose to first go down the path leading to a lifetime of saving and investing. In that case, we'll refrain from buying that first house until we've saved enough money for a reasonable down payment, and then make the wise choice not to spend too much, aka borrow too much, when we do buy our first home.

Living within our means is a good habit to start early. So is saving and investing for the future.

So where are we today? Well, that pretty much depends on our age today, the priorities we established in the past related to housing, saving and investing decisions, and when we made those decisions.

Although it clearly wasn't our intention to do so, too many of us inadvertently and mistakenly chose to live the solitary financial life of a 'housing speculator' and not assume the dual role of (1) prudent home owner and (2) saver and investor.

Here's what happened over time.

Although the average American's wealth has changed substantially as the housing market and stock market have been turned upside down in recent years, when we add to the mix the recent switch from pension plans to 401(k)s, it becomes difficult and even a bit confusing to track exactly what's happened.

However, Declining Wealth Brings a Rising Retirement Risk provides some solid information about our individual financial well being in relation to the equity in our homes, as well as the effect of the ongoing transition from pension to 401(k) plan investing:

"In a recent post, I examined aggregate national wealth from the Federal Reserve Board’s flow of funds statistics. They show that while national wealth is now approximately back to its precrisis level, the composition of it has changed. Much more is now held in the form of such financial assets as stocks and much less in nonfinancial forms such as housing. This is important, economically and distributionally, because the wealthy are much more likely to be invested in stocks and bonds, while the middle class has more of its wealth in home equity. . . .

On March 21, the Census Bureau published data on median household wealth – the median is the exact middle of the distribution of wealth. It shows that between 2000 and 2005, median wealth increased significantly, to $106,585 from $81,821. It then fell to $68,828 in 2011. Thus, although . . . aggregate national wealth has largely been restored, the median family’s wealth is still considerably below its peak and needs to rise considerably just to get back to where it was in 2000.

The reason, of course, is that the housing market continues to lag. As Figure 1 illustrates, virtually all of the change in wealth since 2000 has been accounted for by the rise and fall of home equity, which closely tracks the price of homes. . . .
Median net worth of households, in 2011 dollars. Median net worth is the sum of the market value of assets owned by every member of the household minus liabilities owed by household members; the Case-Shiller Home Price Index is a measure of home values that tracks home prices in 20 metropolitan regions.
On the other hand, households have grown less dependent on housing wealth over time. In 1984, 41 percent of wealth was held in the form of home equity. By 2000, that percentage had fallen to 30 percent; in 2011 it was 25 percent.

A key reason for this change has been the switch from defined-benefit to defined-contribution pension plans. In the former, workers are promised a specific income at retirement, which the employer provides. The employer bears all the risk of market fluctuations.

Under a defined contribution scheme, such as a 401(k) plan, the worker and the employer jointly contribute to a tax-deductible and tax-deferred account from which the worker will finance retirement. Thus, to a certain extent, the growth of pension wealth is more apparent than real.

The worker always, in effect, owned the assets from which his pension was paid; he just never saw them or benefited when the stock market increased, nor did he suffer when the market fell. With a 401(k) account, the worker knows the present value of his retirement saving at the close of the market every day.

There are several big problems in this shift to defined-contribution pension plans. One is that workers don’t take advantage of them or fail to contribute the maximum contribution they are permitted to make. Another is that they fail to invest in stocks and instead put their money into certificates of deposit or other investments that tend to underperform stocks in the long run. Workers may also be unwise in choosing investment advisers and end up paying a lot in unnecessary fees that can be very costly to returns. . . .

Now the first generation of workers who have virtually all their pension saving in defined-contribution plans is nearing retirement, and the news isn’t good. According to a March 19 report from the Employee Benefit Research Institute, only about half of workers nearing retirement have confidence that they have enough money saved for an adequate retirement.

Not surprisingly, retirement saving has taken a back seat to more pressing concerns – coping with unemployment, maintaining standards of living during an era of slow wage growth, putting children through increasingly expensive colleges and so on. People may also have simply underestimated how much money they needed to save in the first place. . . .

According to a March 15 study from the Urban Institute, young people today have considerably less wealth than their parents did at the same stage of life.

Factors include young people buying homes at a market peak and hence suffering disproportionately from the decline in home prices; they also put less money down, making it more likely that they have negative home equity. Younger workers have also tended to marry at a lower rate, have lower incomes than their parents, pay much higher costs for health insurance, and are more likely to graduate with college debts.

What’s really depressing about these studies is the lack of solutions and the likelihood that the problem will only get worse."

Summing Up

The collapse of housing prices in recent years has caused a multitude of problems for Americans trying to save for retirement.

Now the effect of the transition of retirement plans from pensions to 401(k)s is having a similar negative impact.

Both housing and retirement planning are in need of a total rethink by We the People. We can't continue down the financially speculative path we've been on for far too long now.

No matter what we believed when we were younger, buying a house with borrowed money and then planning to sit back and watch its value grow quickly is not a ticket to guaranteed wealth. It's speculative behavior.

And becoming 'financially literate' about how 401(k) plans work must become an essential part of every responsible individual's retirement planning efforts.

The 'good old days' of making lots of money off homes and retiring with a guaranteed pension for life are gone forever. In fact, they were always more illusion than reality.

So let's all wise up about the new rules that apply to home ownership and personal retirement planning and preparation. And let's pass that wisdom on to those who will follow us.

We can at least do that.

That's my take.

Thanks. Bob.

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