Retirement is the #1 financial worry with 65% of Americans worried about it and a majority thinking about it 4 times per week. The core problem is uncertainty – people have no idea how much they need, because we have created a system around building assets instead of income.
We spend our lives saving up a big pile of money in an effort to secure our future against a bewildering set of future risks including market returns, inflation, healthcare and longevity. This is spurred on by the vast majority of players in the financial services industry who want us to save as much as possible and/or “invest” in often complex, opaque and expensive products since their income is based on a percent of your assets (AUM) or on transaction fees where the price is not clearly marked.
An average 401(k) investor who pays 1% investment fees on a portfolio earning 4% will lose about 33% of their returns to those fees over a 20 year period. Put another way if you have $1M, then $400K in returns are lost to fees over 20 years (fees that go to your fund provider, broker or financial advisor).
I’ve talked with hundreds of our users who are planning for retirement, most of whom have $500,000 to a few million saved and they are all worried about whether they have enough and how they will generate retirement income and manage healthcare.
How we got here
Recently I hosted Nobel Prize winner Bob Merton on our podcast to discuss his thesis that our retirement savings focus on assets vs. income and the resulting systemic misalignment is the core of the problem .
Historically many companies provided lifetime pensions and they measured their ability to deliver on their future pension obligations. Retirees who got a guaranteed income from their pension reported being happier; because of the certainty and simplicity of getting paid monthly and just having to keep spending inline with income. Life is more complicated and stressful when you have to design and implement your own “retirement paycheck” and make sure it lasts your full lifetime.
The shift to an asset focus came about as companies moved away from pensions (since it’s not their core business to guarantee future income) and the modern 401(k) plan emerged as the core of Americans’ retirement portfolio by happenstance not by design. At the same time as pensions faded away and companies started allowing employees to contribute after tax dollars to retirement, Section 401(k) of the IRS tax code was added as part of the Revenue Act of 1978. Section 401(k) was originally added for a special interest group of Kodak employees who wanted to invest some of their pretax salary into company stock. The modern 401(k) plan came into existence when Ted Benna a benefits consultant realized that Section 401(k) could be repurposed to enable executives and employees to contribute pretax earnings to retirement instead of after tax dollars.
Once 401(k) plans started growing, the core metric shifted to asset levels from lifetime pension income and an entire ecosystem emerged around helping people grow their assets. At the same time the responsibility for saving and managing the money shifted from pension administrators (who were financial experts) to everyday people – so everyone had to become a financial expert. Now we live in a world where there are about $5.3 trillion dollars in 401(k) plans which represents 19% of the total $28.3 trillion in total U.S. retirement savings, according to the Investment Company Institute. If we assume that fees across mutual fund fees and advisors are 1% of the 401(k) assets, that is $53 billion in fees…per year. Much of these assets are held by people approaching retirement and there are many firms in the financial services world eagerly waiting to serve them. Unfortunately, few are fiduciaries (a person or organization that is obligated to act in the best interest of the client).
How Can People Do Better Today?
While Professor Merton and other experts have a number of ideas about creating new simple and efficient investment vehicles that people can steadily invest in over time and deliver guaranteed lifetime income, the reality is that retirees need to make due with the tools that exist today.
Fortunately, the trend towards efficiency and lower fees is working its way through the financial services ecosystem. The charge is being led by the aptly named Vanguard and groups like the Bogleheads and FIRE (Financial Independence Retirement Early) followers who are focused on low fee index investing and efficiency. The “Vanguard Effect” refers to the decrease in fund fees across the whole industry and you can thank Jack Bogle, the founder of Vanguard for this. He created a culture of low costs, innovated the index fund and organized his company to be owned by the fund investors so they and the firm were aligned around driving fees lower. In fact, Warren Buffett recently wrote in an annual letter “If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle”. Rick Ferri did a good podcast interview with John Bogle recently on the history of index investing.
There are also a number of tools and strategies available to people planning for retirement that can help them build a retirement plan and make the most of their savings and investments, manage expenses and debt, understand their healthcare options, explore where to retire and ways to use home equity and find new ways to create lifetime income. An easy way to get started is to use a simple retirement calculator.
These are the elements that need to come together into an integrated solution to fix retirement.
- Education: Make a personal finance course a requirement to graduate high school. Today only 16.4% of high schools students are required to take a personal finance class in high school. It would also be ideal if employers offered financial education as part of an overall financial wellness offering.
- Fiduciary standard: Embrace product & practice principles that are in line with a Fiduciary standard – have all products be efficient, low fee, simple, transparent and designed to be in the best interest of users.
- Increase access to savings & investing vehicles: Innovate new simple financial products that provide lifetime income. Incentivize employers to offer better retirement savings options and provide a government supported alternative if there is not an employer option.
- Default best practices: Research shows that setting appropriate defaults in retirement plans make a huge difference in outcomes. Features like auto enrollment into a 401(k), defaulting the savings rate, defaulting an appropriate portfolio allocation can materially move people towards retirement security.
- Enable anyone to create and manage their own retirement financial plan: Equip everyone with a portable living plan that is owned by the consumer and managed over time.
- Enable collaborative planning with expert advisors who are fiduciaries: They can coach & support people and help them effectively take action – ideally a digital / human hybrid solution to maximize effectiveness while minimizing cost.
The good news is that many of the elements of a complete solution are known and consumers are pushing the financial planning industry to get more efficient and lower costs for many core financial products. The next phase of the evolution involves doing the same thing for guidance and advice.