David R. Evanson
Privately Published, Spring, 1995
Forty years ago the title to this article would have likely provoked ambivalence. In fact, it could have titled an article about the strength of the social contract here in America, and why, for ordinary folk, the burden of investing had effectively been removed.
Today the title may still provoke the same ambivalent emotion among working Americans. Unfortunately however, in these times, itzzs the wrong emotion. As an investment professional, I am obviously bullish about investing. I always have been. But, for working Americans, the activity of investing must take on a higher priority. The argument is a three-legged stool. .
The Clock is Punching Back
For instance, look at the changing landscape of corporate America. Eighty percent of the new jobs are created by small business. Whatzzs more, therezzs a better than average chance that someone working for one of these emerging upstarts is going to get laid-off fired, or down-sized off the map. The Department of Labor statistics reports that on average, Americans will now change jobs six times in their career.
And then therezzs the global economy. Itzzs nice to talk about, and people sound important when they say it, but it also means that other nations now actively and effectively compete with America. American business has responded with an almost ruthless drive for increased efficiency and bottom line results. Companies that once had total franchises, utilities, telephone companies, even IBM, now have to compete. So they watch revenues, earnings per employee, they outsource, they cut to the bone.
This means workers looking for a company to take care of them for their whole life arenzzt going to find one. And that leads to three very important reasons to invest. First, the burden of financing retirement has shifted back to the worker. Second, employees will likely need to finance several bouts of unemployment, by the Bureau of Labor Statistics, at least five. And finally, because the only real career certainty is starting a business or going it alone, investing may be the only way to get the first infusion of capital the enterprise will need.
An Insidious Element
The second leg of the argument focuses on inflation. Why? Because inflation destroys capital and investing restores it to full health again.
It goes like this. Five percent inflation, exerting its influence unchallenged on personal assets will reduce the purchasing power to just 78 cents on the dollar five years later. In this scenario, a fixed income that bought $30,000 of goods and services at the beginning of five years can only buy the equivalent of $23,500 worth of goods and services at the end of five years. What a haircut!
In theory you could stay even by simply keeping funds in a money market account, or buying riskless Certificates of Deposit (CDs) from banks. Theoretically unscathed, the necessity of investing would once again be avoided.
Unfortunately, this argument is rife with holes. First, just staying even is, for many people, just keeping their nose above water. Not investing to preserve that kind of status quo just doesnzzt add up. Second, most riskless (read also effortless) forms of investment, i.e. CDs and money market funds, are tied to inflation, and in many instances are lower than the rate of inflation. So, if your money is going forward at 3% and backwards again at 4%, guess what? You go backwards by 1%.
But perhaps the biggest hole in the argument that zzmy investment portfolio sits in a money market thank youzz is the T word. Taxes. People in a 28% bracket are, in most instances, in a 33% bracket after the state gets through with them. This spells trouble. It means that 33% of the 4% return on a money market or CD, i.e. 1.32% goes to taxes. After inflation of 5% has its way, the real return on these so-called investments is a negative 2.32%. The best you can say for CDs and money markets is that they slow down the rate at which inflation and taxes take you backwards.
The real cure is to invest pro-actively.
Outside the Beltway
Herezzs the third leg of the stool. And this one doesnzzt take an investment professional to figure out. Reliance on the Social Security system to provide adequate retirement benefits is like setting sail on a the Titanic. Even the Social Security Administration will tell you that without any changes to the program it will run out of money by the year 2030. And without making the remarks here politicized, consider the track record of the Social Security Administration. In the beginning, retirement benefits would never be taxed. Now up to 85% of the benefits are taxed with the net effect of lowering benefits or increasing contribution rates. Neither bodes well . . . Then therezzs the retirement age. Itzzs going up starting in 2000, and for people who retire at 62, benefits are going down . . . A republican senate contender ran, and won, in 1994 on a platform that had a retirement age of 70 as one of its planks . . . In 1994 there are approximately 3 working Americans for each American on Social Security. The Social Security Administration projects a ratio alarmingly close to two to one . . . Then therezzs Congresszzs $420 billion IOU sitting in the Social Security trust for cash that was borrowed to fund other programs.
Will Social Security be functioning when you retire? Thatzzs hard to say. But whatzzs fairly easy to predict, based on past experience, is that Social Security benefits will be less robust when you are ready to start taking them. You can get mad. But thatzzs not half as productive as getting prepared. The best way to do so is to start investing today.
Capitalism to the Rescue
The silver lining in this cloud is that none of this has been lost on financial institutions. Changes in the tectonic plates beneath our feet have spelled opportunity for brokerage firms, banks, and insurance companies, and they have all rushed in to fill the void. Happily, there are now several products and services that make it feasible for individuals to invest directly for their own futures. And while these products have overcome the many barriers that once existed between investors and financial services, they cannot overcome the ambivalence of individuals toward their own financial future. That must come from within, or from even a passing understanding of some of the trends and issues described in this short article.
If you are now committed to investing for the future, be sure to read next monthzzs column, which will address how to identify your risk profile, and how this profile influences the kind of investments you should make.