One must save for retirement, because savings transfer purchasing power from the present to the future, and in order to stop working one must have claims on future goods. This is obvious (if not, read this post). Since such claims are denominated in dollars, purchasing power is determined by the supply and demand for dollars versus the supply and demand for goods. This should also be obvious.
Thus, a person’s ability to retire will be determined by his relative wealth.
In other words, how much money a person has compared to other people, and how much money a person spends compared to other people.
Wealth here is defined as having enough purchasing power to pay current bills.
These days, the widely popular solution to retirement can be summed up in the following list of words: “15%, (ROTH) IRA or (ROTH) 401k, index fund, and compound interest.”
The reason for its popularity is that the simplistic assumptions behind the concept are easy to understand, which has enabled Nobel laureates to write academic papers on the subject; investing requires little effort; and it has given Wall Street a new product to sell to Main Street.
Thus many people have been misled into believing that they can get higher returns by putting in almost no effort except hypnotically chanting the “magic of compound interest” while waving their hands and perhaps showing “what if” scenarios based on historical results.
Well, those results are in the past. And this history may never happen again.
In the 19th century, a 4% return was a great deal. In the 20th century, we have come to expect a 10% return. This has been achieved through a massive transfer of wealth from the biosphere to the human world. In other words, humanity has been encroaching on the biosphere and in the process turning it into furniture, sidewalks, clothing, playgrounds, etc. It is estimated that the total mass of humanity (humans and everything related to them) now weighs ten times the combined weight of all other life on the planet. How unfortunate! This means that there is less “other life” left to consume and convert into valuable GDP or valuable stock market growth.
But GDP grows only about 4% a year, so to get to 8% to 12% yields, several factors had to be factored in. The United States has the natural advantage of having been inhabited by a much smaller Neolithic population. Colonial Europeans were able to get access to vast tracts of land for free because it wasn’t already inhabited by anyone’s children. Even today, the population density in the United States is less than half that of Europe, but thanks to the “magic” of having more than two children, the population density will reach parity in a doubling period or two. At that point, Americans will rarely see a wild squirrel. (I grew up in Europe and was 18 before I encountered one in the local woods for the first time.)
The final advantage here is that the magic of compound interest is particularly magical when it benefits a few people, shifting wealth from consumers to owners of capital. If everyone becomes a owner of capital, this will not work. For example, when demand for bonds increases, interest rates fall because the price rises. So if everyone buys bonds, interest rates will fall and yields will fall. Likewise, if everyone buys stocks, the price level will rise and their value will be less likely to rise. Blindly buying index funds all but guarantees that stocks will be mispriced overall – and while index funds will be internally diversified, diversification does not eliminate systematic risk, which is exactly the kind of risk that investing in index funds currently creates (see here for more).
Additionally, if everyone can get to the magic 8-12% (choose your level of optimism), a general rise in the price level will result. This will be inflation caused by the demand for more paper assets chasing a smaller number of real goods.
At the systemic level, if everyone started saving more (and a false positive could be produced by borrowing from outside the economy or, more sinisterly, by forcing the government to do so), we would see tremendous productivity growth. But sooner or later, this would cause a bubble in some sector of the economy, as happened in the late 1990s when too many fiber-optic cables were laid or too many houses were built that people could not afford to live in them after five years.
So how do we solve this problem?
In my opinion, the industry is dying. If the Earth is a room, we are now painting ourselves into a corner by taking 75% of our potential for expansion. There is simply no way to continue on the current path because the world is not big enough to expand the industrial footprint of the Western world (1 billion people) to the rest of the world (5.5 billion “others”). [baby] Continuing this approach no matter what would turn human interaction into a zero-sum game where wealth generally flows from the deprived to the rich (a general rule in complex social structures). We have already seen the first attempts to secure resources through military and economic means.
If voting (what people do, not what they say) is to continue on the current path, the best way to ensure happiness is to have more than everyone else. Whoever has the most retirement money wins. At the moment, that can be easily achieved by having more money than is popularly recommended.
Taking the necessary steps toward financial independence, preferably before anyone else finds out, the world could provide six billion people with a standard of living equivalent to the average Mexican if wealth were equalized, which is not bad although it is somewhat lower than what readers of this blog may be accustomed to. However, wealth is unlikely to be equalized, so it is better to be above average.
The alternative is for humanity to choose to pull its head out of the sand. This will be very difficult. First, developing countries want the opportunity to industrialize even if it is physically impossible. Second, the entire West must move from a “more is better” mentality to a “enough is enough” mentality.
If this were to happen, traditional retirement as we know it would no longer be an option, as there would be no over-productive/over-consumptive society to rely on. So the idea of saving a million dollars and living a good life in retirement would become obsolete. The reason is that there would be no things worth a million dollars that could be bought with that million dollars. Things would just be more expensive. But the good news is that people would have more time for everything else. For example, there is no information limit.
The solution to both problems is to accumulate more than average (since the average is so low, this is not too difficult) and learn how to live well in a small space.
I hope this doesn’t mean everyone is suddenly going Twitter crazy.
😉
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