Sunday, September 21, 2014

American DNA

I'm making money in the stock market, and I feel guilty about it. I feel good, too, of course, but strangely uncomfortable. I'm not doing anything to earn my rewards. The market is just going up. It has tripled from its low of five years ago. If you've had money in the market over that period, and left it there, you've made a lot. 

Trouble is, most folks haven't. Less than half of us own stock, and most who do are well off: the top ten percent of households have stock investments totaling $282,000; for middle class households, the average is $14,000. [1]  Some got spooked by the crash in 2008 and stayed away. Many just didn’t have much cash to spare. And the system seemed rigged in favor of the big guys. They didn't trust it. So they kept what money they had in savings accounts that earned almost nothing while those who bought stocks made a killing.

You have to have money to make money, the old saying goes. True. But the big reason most of us make lousy investors, and eventually give up, is the brutal whiplash of greed and fear. As my grandfather Clayton, a stock broker who began his career in 1929, put it: When the market is going up, people think it will keep going up. When it goes down, they think it will never recover. This causes them to buy high and sell low.

If people don't have the money or the temperament for the stock market, they shouldn't be in it, you might say. Maybe. But consider this: the stock market is the only reliable way to stay ahead of inflation and make a real return on your investment. Savings accounts don't do it. Neither do bonds, not very well anyway.

When I say stocks, I'm talking about the broad market. I don't think most of us would make good individual stock pickers. The S&P 500, for instance, is a fair proxy for American business. As goes American business, so goes the S&P 500. There are ups and down in the business cycle, but over the long term America and the S&P 500 have grown steadily. Over twice as fast as bonds. Three times as fast as inflation. If you want to have money for retirement, put it in the S&P 500 or a similar broad market index and forget about it until you stop working.

Many folks have a hard time doing that, though. There are a number of impediments, including the two mentioned above: not enough money and not an investor temperament. There are other difficulties too. There's not, for instance, an easy way to invest very small amounts in stocks periodically and hold them for the long term. But perhaps the biggest problem is that despite attractive returns there is not a powerful incentive to choose putting money away in stocks as opposed to buying a new car, a new cell phone or a new outfit. Investing is easy if all of your basic and even frivolous needs are met, but it takes either the frugality of a Quaker or a strong economic incentive to make a weekly deposit in your investment account and skip going out to dinner on Friday night.

Let’s get the easy part out of the way first: the mechanics of making investing easy. What we need is a big institutional investment vehicle that is like piggy bank: put in your loose change at the end of the week and let it grow. Maybe it could be run by the government, maybe private firms. The cost of investing in the S&P 500 through mutual funds like Vanguard or Exchange Traded Funds like SPY has been pushed down to nearly zero, so the costs of the enterprise would be primarily related to bookkeeping and marketing. In the computer age, bookkeeping will be easy. The marketing will be tougher. It will require something like going door to door to convince people to put a little something away for their future. Tough as that may sound, if the funeral industry can sell funerals in advance of need, a smart marketer ought to be able to use the same logic to sell retirement investments: You don't want to be a burden to your children, do you?

Now, let’s tackle the tough part: providing an incentive to invest. We are a nation of consumers, not savers. Seventy percent of our GDP comes from consumer spending. So we’re talking about changing pretty deeply ingrained habits. To do that, we’re going to have to come up with compelling reasons for people of modest means, for whom disposable income is precious and consumption is a way of life, to put money away and leave it there. Here are two simple ideas:

1. Matching government contributions for those willing to sock away their funds until retirement. The way many private employers match employee contributions to retirement accounts.

2. Tax free returns. We already have Roth IRAs, on which gains to the owner are never taxed. The requirements for contributing to a Roth-like retirement account could be relaxed to permit broader use (apart from income earned, for instance).

For a family who saves regularly, the retirement payoff could be huge. Let’s say they save $1,000 per year for 40 years and the government matches their annual contributions. And let’s assume a 7% annual real return (net of inflation) for the stock market, which is the average since WW II. [2]  At retirement the family’s investment account would have a value of $400,000. And that’s after taking into account inflation. (Since WW II the S&P 500 has returned 11% before adjusting for inflation, which would make the nominal value of the family’s investment account in 40 years $1,164,000, but in terms of what that amount of money would buy 40 years in the future, the value would be the same as $400,000 today.)

Why would the government provide these incentives? It would have to pay for them with tax revenues from other, presumably wealthier, people, so it would amount to a wealth transfer. Why do it?

One way or another a moderately compassionate society always gets stuck with the tab for caring for those who can’t care for themselves. We do this now through Social Security, Medicare, Medicaid and other social welfare programs. Why not increase the incentives for people to put more of their own resources toward their ultimate well-being? And why not harness the power of the equity markets to add to aggregate available retirement resources? (The Social Security Trust Fund is by law required to invest only in obligations backed by the full faith and credit of the United States;[3]  safe but low returns, lower even than corporate bonds.)

From the government’s standpoint (and therefore all of society’s), the economic benefits are powerful. Let’s say that 30 million families enroll in this new program. If they all invest $1,000 per year and the government matches their contributions, the families and the government would each be putting up $30 billion per year. Run that out for forty years and the total invested would be $2.4 trillion, half by the families, half by the government. If those investments earned the 7% per year average of the post WW II S&P 500, the families would end up with $12 trillion in inflation-adjusted value. In terms of social welfare spending, that’s a pretty good bang for the buck for the government: $12 trillion for its $1.2 trillion investment; a ten for one multiplier.

Think of it this way: Instead of the government matching citizens’ contributions, imagine citizens matching the government’s contributions to their future welfare. And we’d be using using good old American Enterprise (in the form of the stock market), which we love so dearly and which built this country, to provide the growth in value.

I don’t know how such a system would fit in with the ones we have now, particularly Social Security. I don’t think we have to know that for sure to get started. It will take decades to change savings habits; only four percent of us now have enough saved for retirement. [4]  But over time this new approach could lead to a categorical shift in the compact between government and its citizens from “let us help you” to “let us help you help yourself.”

And there might be another huge benefit: shifting us from a nation of spenders to a nation of investors. An economy based on consumption must constantly artificially boost consumer spending, with the result that you end up, as we have, with a lot of old folks with scant resources. It’s likely that this much new money would distort investment markets, perhaps even lower returns, but there would be more capital for new enterprises to access. We might shift from a nation of spenders to one of savers supporting innovation.

What of the tax break? Many want to reduce or eliminate capital gains taxes, but since investments are now principally the province of the wealthy, reducing capital gains taxes only adds to wealth inequality. This new plan would create a new and potentially large group of middle class savers who would be benefited by eliminating taxes on their retirement accounts; as such, it would mitigate rather than exacerbate wealth inequality.

The last great retirement welfare programs were Social Security and Medicare. They are good programs, but we are uneasy with them. We see the problems corporations and other governments are having with their underfunded pension liabilities, and we look at our aging population and we just know that as a nation we are likely to face similar funding shortfalls. We are free-marketers at heart, not socialists. But we are a compassionate people, as well. Using free markets and tax breaks to provide savings incentives and savings growth is in our national DNA. 

We talk a lot in this country about not liking welfare. Even those getting it, don't like it. People want to be as self reliant as they can. This would help them get there. And it would help the government regain sound fiscal footing as it supports its citizens and invests in their future.



1 comment:

  1. Very creative. Sounds a little like a variation on privatizing Social Security.