Black Label beats retirement planning

If there is no meaningful way to boost one’s quality of life through strong investment returns through retirement, it makes more sense to reconsider the benefits of longevity in the first place

There’s no time for us, there’s no place for us …. What is this thing that builds our dreams, yet slips away from us … Who wants to live forever, who wants to live forever….” — from the song ‘Who wants to live forever’ by Queen

When Count Bismarck initiated pensions more than a century ago, the idea was to provide for people who had miraculously survived to the ripe old age of 60, given that weighted average life expectancy at the time was a stirring 62 years. In other words, you work for 40 years or more of your adult life, and get about two years’ worth of life support at reduced wages. Not quite the party one hopes for these days, in other words.

Label

Current pensions in Western Europe of course tip significantly to the other end of the spectrum. Even as life expectancy has improved dramatically to well over 80 years, retirement age has declined in many European countries, averaging less than 60 years in most cases. For some stressful jobs, like being a hairdresser in Greece, retirement age is even lower at 50 years.

Ah yes, the Greeks and their hairdressers. Since pretty much every Greek I have ever met has fairly unkempt hair, one assumes that hairdressing is a particularly stressful occupation. Or perhaps Greeks never go to the hairdressers, which is why it is stressful to be one occupationally. Either way, the idea of retiring at 50 puts into focus the notion of having retirement that exceeds one’s working life by a useful margin (25 years of working against 35 years of retirement).

Away from Western Europe though, very few countries offer iron-clad retirement guarantees to individuals outside the public sector. Many companies switched off their hyper-generous ‘defined benefit’ schemes under which employees secured a particular level of income (say 3/4th of their last drawn salary) to the more affordable ‘defined contribution’ schemes wherein employees got the proportional income derived from their own contributions to savings over their working lives.

To the extent that one contributed a fair portion of their income for savings and secured a decent investment return (say 10%), one could project a pretty decent income base into retirement; which in turn helped people to decide the right retirement age – 55 or 60 or 65 depending on their personal circumstances.

In the last few years though, this math has gone awry if for nothing else because investment returns have declined massively. Private sector workers in Europe (especially the UK whose safety net is abysmal) have looked at their public sector counterparts and their defined benefit schemes with mounting envy. Politicians of all hues have jumped on the bandwagon of “protecting retirement incomes” from time to time; but until these become law, the reality has been

  • People expect lower returns on their savings
  • Therefore they have to save more every month
  • Saving more is not usually an option for stretched budgets (or at least does not make a substantive difference), therefore the other option is to work more years

Thus it is that the idiotic policies behind ‘quantitative easing’ and other Keynesian wet dreams have come to cause a substantial collapse in private sector consumption even as governments struggle to balance their books and prioritize spending on items that could potentially add economic value, boost competitiveness and thereby improve longer-term savings.

This week, there were two studies released from vastly different quarters that encapsulated the crux of both sides of the problem:

  1. McKinsey, the consulting company, issued a long paper on the decline of investment returns and implications for the ‘millennial’ generation joining the workforce (1)
  2. The St. Louis Fed issued a policy document that described negative interest rates as “tax in sheep’s clothing” (2)

It is perhaps not so odd that people approaching the global economy from vastly different starting points end up with observations that are essentially intersections:

  1. Negative interest rates act as a tax on consumption; and push down investment returns
  2. Lower investment returns reduce future expected value of savings
  3. This pushes people to save more, invest more and work longer
  4. Reduced investment return expectations put increased focus on the costs of saving – Warren Buffett weighed in on the rather divisive subject recently (3)
  5. Without the chances for ‘extraordinary returns’, more people slip back into (a) above

What remains unsaid in all of the above is the role of regulators, specifically those monitoring pension schemes (such as ERISA in the US) and insurance companies that provide funds for investment returns. Regulators typically force such investment managers to observe the following restrictions on their portfolios

  • An appropriate mix of bonds and stocks depending on the weighted average age of scheme participants (typically 60:40 for younger profiles going to 40:60 for older ones)
  • Limited exposure to stocks and bonds of emerging markets
  • Limited investments in commodities, hedge funds and other alternative investments
  • No investments in collective schemes and local businesses
  • No direct lending to businesses and individuals

Much as a number of commentators have criticized the asset management industry globally of gross incompetence, the fact remains that most managers are overly constrained by their mandates; and simply cannot portfolio rebalancing of the type that would save their investors from losses over the longer term.

German bunds at -1% ? Well, those are a buy then given the need to put enough money into European bonds (if you’re a European pension fund manager); and one cannot simply allocate everything to Greece 5 year bonds yielding 8% now can we (and anyway, that’s not allowed by the fund rules which restrict exposures to lower rated countries to under 5% of the total portfolio).

Explained more simply, it is ‘possible’ that in an unconstrained investment environment, the move towards negative interest rates would have generated enough portfolio churn away from riskless alternatives to more risky assets in turn helping investors reduce their overall savings rates (or at least the perceived need for individuals to save more). Without removing such constraints, it is almost no wonder that the move towards forcing investors to take on greater risk simply dissipates in the face of the realities of investing today.

You may well counter the above arguments by citing the ability of investors to manage their own savings without relying on outside help. This is possible in a few countries, but in most places there are significant tax advantages associated with approved investment / savings plans (e.g. 401-K plans in the US) which are not available for non-scheme participants.

If one does the math between the certainties of paying taxes today (taking the remaining money and putting it into higher risk alternatives) versus the possibility of near-term investment losses against longer-term potential improvements in returns, the easiest conclusion is to avoid the temptation of going it alone. To make matters worse though – game theory dictates that if everyone decides to follow this path (of forced saving into lower risk portfolios), returns for everyone would remain lower for longer.

The problem then can be summarized easily as one of the denominator vs the numerator. If there is no meaningful way to boost one’s quality of life through strong investment returns through retirement, it makes more sense to reconsider the benefits of longevity in the first place. In the absence of any expectations of central banks and governments understanding these dynamics and enacting structural reforms, based entirely on that wonderful song by Queen my preferred retirement option therefore becomes

Black Label with soda water and a little ice please. Actually, make that a double.

Notes

  1. http://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/why-investors-may-need-to-lower-their-sights
  2. https://www.stlouisfed.org/on-the-economy/2016/may/negative-interest-rates-tax-sheep-clothing
  3. http://blogs.wsj.com/moneybeat/2016/05/02/warren-buffetts-epic-rant-against-wall-street/

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