Newsletter February 13, 2010

InvestorsFriend Inc. Newsletter February 13, 2010


Have you noticed that the whole concept of saving for retirement has morphed into an obscene, irrational and hideous Monster? This Monster is a huge threat to corporations, all levels of governments, employees and even current retirees.

Consider the current situation:

Individuals are told they need to save at least one million dollars to achieve any kind of decent retirement. Some experts have suggested that people need to save as much as 34% (based on recent articles in the Financial Post calling for the RRSP limit to be raised to 34%) of their income for retirement!! Corporate Pension plans are reported to be under-funded. Governments plans are under-funded or even unfunded.

The President of the C.D. Howe institute went so far as to suggest that in order to replace 100% of income in retirement, you need to save half your income. He bases this on the absurd notion of near-zero returns.

Some large corporations have gone broke partly because of pension obligations. This has led to cuts to the pensions of retirees and cut the retirement plans of displaced workers off at the knees.

Pension contributions have sky-rocketed for both employees and employers. Traditional pension plans that often provided a “guaranteed” pension amount of 50 to 70% of earnings for those with 30 to 35 years of service are being closed down and replaced with “defined contribution” pension plans that provide an unknown pension amount that depends on the return earned.

Accounting rules result in corporate earnings being subject to large gains and (more typically) large losses) as pension assets fluctuate and as estimated pension liabilities fluctuate.

The Pension Monster was created by numerous factors including:

  • Stock market returns that have been lower than assumed in the plan designs and which are now assumed to remain lower.
  • Low interest rates that dramatically increase the pension obligations, because it takes more money to fund a fixed pension obligation when available interest rate investment rates are lower.
  • The fact that pensioners are living longer in retirement than expected.
  • The Societal expectation that the retirement age should remain steady or even decline even though people are living much longer and even though the nature of work has changed to be much less physically demanding in most cases.
  • Early retirement incentives and subsidies build into many pension plans.
  • Unrealistic expectations of opulent retirement lifestyles.
  • Separation of pension plan management from employers, leading to managers that don’t care how high the pension contributions go.
  • A financial industry that has every incentive exaggerate the amount of savings that are needed.
  • Declining birth rates whereby there are fewer workers for each retiree, a situation that is will get much worse in the decades ahead.

This retirement savings monster has now become the “tail that wags the dog” for many corporations. (It is not unusual for the pension assets to be larger than the shareholder’s equity in the company).

This retirement savings monster is threatening to become the “tail that wags the dog” of our very lives! How crazy is it that people are being told they need to scrimp and save 20% or more of their income all their working lives in order to enjoy their retirement? It’s gotten to the point where people are being told to sacrifice all their working lives for the sake of retirement. And they are told that this is the normal thing to do. They are told that they are failures if they can’t do that. The reality is that this 20% savings suggestion is almost impossible except for cases where the employer pays at least half and the other half is deducted at source into a pension plan.

The current Retirement Savings Monster implicitly assumes that all work is drudgery and that we are all saving to eventually escape from the drudgery of work. This Monster asks you to treat your entire working life as something that you look forward to escaping from as soon as possible.

When we are 20 years old, we expect that we will cover the expenses of our lives by working. We are not told to live in fear of how we will pay for things in our 50’s. We tend to get a job and pretty much assume that in our 50’s we will be perfectly capable of working to support ourselves. But the financial industry asks us to please panic about how we will pay for things in our 70’s. We are encouraged not to even think about working at that age. We must please take huge slices off our current incomes in our  30’s,40’s and 50’s and give it to financial planners lest we end up eating dog food at 70. This is an insult to seniors to assume that they are not capable of any work and that neither will we be at that age.

Did this system ever work?

Yes for a generation or two the formulas seemed to work for those with pension plans. Partly this was because if the pension plans of their parents were underfunded, the larger baby boom generation helped make up that shortfall. Also the stock markets gave unexpectedly lucrative returns in the last half of the 20th century. The first big wave of corporate pension recipients who retired in the 60’s and also those who retired in the 70’s had not yet been indoctrinated with the idea that they should be able to afford to do things like travel extensively in retirement.

But as of now the system is not working. The “pension” system has essentially proven in recent years that it is not capable of funding the longevities we expect today – not with retirement ages of 65, 60 or even 55, and not without 20% (or higher) contribution rates that choke off living today for the sake of retirement.

As far as people saving up their own funds for retirement outside of a pension plan, that has not worked on any wide scale. A majority of workers cannot afford to make the contributions that are required. Only a small minority (ironically typically those with good jobs and pension plans) and a few people like doctors and lawyers have been able to accumulate truly significant retirement savings on their own. Also some unusually dedicated savers and unusually successful investors.

The Origins of the Retirement Savings Concept

In the beginning I imagine our hunter-gatherer ancestors had little ability to even store any food for the days when they would be physically unable to provide for themselves. I imagine that retirement was not a concept that had yet been invented. I imagine the elderly were looked after by family during any (probably short) period of age-related infirmity until they died. Can you imagine that these people would have told an able-bodied but older person that their days of hunting and gathering were over and that they should go relax for the rest of their days? They would not have done that because no doubt every able body was needed for subsistence of the group.

When did the concept arise that older people who were still able to work would nevertheless stop working and be taken care of by government programs, corporate pensions, and or personal savings? And when did the ability of a few to do this become an expectation that everyone should be able to do this? To an economist, this should be a rather strange concept. Generally in any economy whether primitive or modern there is always a hunger to consume more goods and services. Clearly the early idling of vast numbers of older people (before infirmity requires it) must diminish the amount of goods and services that are produced and available in total. Mathematically, this in turn must lower the average standard of living. One cannot raise living standards by encouraging less production in the economy.

When programs like old-age pensions, social security, corporate pensions and even personal retirement savings first were developed, the reality was that people did not live that long in retirement. The concept was for example to work 45 years or more to age 65 and then “enjoy” a short retirement. It was much easier to fund this type of retirement when many people died before they even reached 65 and the average retirement life span was under 10 years.

Somewhere along the line the unrealistic and economically harmful notion arose that it would be possible to work for say 35 years and somehow fund an idle but healthy retirement of 25 years or more. And to do it by saving about 10% or less per year. The fact is, that math don’t hunt!

For millennium untold, humans lived happily without any retirement savings. Now we are told it is a disaster not to squirrel away some 20% per year!

Let’s Bring Retirement Planning and Savings Back to Reality

The solutions to the retirement savings “crisis” that have been proposed by the pension and financial planning industry all seem to involve ever higher contributions (and not coincidently) ever higher Commissions for these managers. The financial planning industry also constantly calls for more tax subsidies for saving in the form of higher RRSP contributions and other ways to save money and not pay any tax on the earnings.

New and economically rationale solutions are needed.

A logical system of retirement planning needs to recognize that people are living longer and that most people are capable of working and earning a living well into their 70’s and often 80’s. We need a system that recognizes that work is often something that we enjoy doing and get fulfilment from. We need a system that recognizes that leisure time away from work is something we should enjoy every year over our whole lives and not something to be hoarded for “retirement”.

A logical pension system would always be portable between companies. It would eliminate today’s features like overly generous early retirement provisions that are simply not mathematically justifiable.

A logical system of retirement would encourage people to keep on working and being productive (remember more workers means more goods and services to go around) and would certainly not encourage the early idling of millions of people.

A logical system of retirement would include a phased departure from work and not a system where one goes from full-time work to retirement with no transition.

When our older decades are viewed more logically as a time of reduced work and reduced paid earnings, rather than of no-work, we can stop obsessing about saving completely unrealistic amounts. We can relax and do things like take a year-off periodically through our working lives. We can take more weeks of vacation or un-paid time off and use some of the money that we are now being told to save. Yes that will deplete our savings, but we will make that up by working part-time in “retirement”.

Let’s try to remember that retirement savings are for the benefit of the future retiree and not the investment industry. I am all for saving money but let’s shoot for realistic numbers and not for 20% of our gross pay.

Let’s slay the Retirement Savings Monster and start living a little more for today.

The Down-side of Tax Assisted Retirement Savings Plans

Things like pensions, RRSPs, RESPs and Tax Free Savings Accounts are all forms of tax-assisted savings. If you use these plans then your taxes are reduced. So that’s good…(for you).

But who is harmed by this?

Well, if everyone could use these tax-saving investments plans equally then no one would either benefit or be harmed. The tax rate would be higher than it would be in the absence of these plans but then we would all save taxes by using them which would cancel the impact of the higher tax rate and no would benefit or be harmed in the end.

It is a mathematical fact of course that tax deductions for these savings plans results in a base income tax rate that is higher than it would be in the absence of these plans.

So what about a high income earner who has no pension plan? He or she is faced with a higher tax rate to make up for the tax deductibility of other people’s pension contributions. Both the employee and the employer share of pension contributions are income tax deductible. How ironic, not only does this person not have a pension plan, their taxes are higher in order to allow the tax deduction for those with pension plans. But this is all good right, because governments need to encourage corporations to have pensions plans, right? Well maybe, but it is really a dangerous and slippery slope when we allow government to decide what is good or bad for us and to use tax policy to encourage it. And who says that encouraging people to have pensions so that they can ultimately stop contributing to the work of the world is really such a good thing?

Any high income earner who does not contribute at least the average amount to RRSPs, RESP and now Tax Free Savings Plans is effectively paying  a higher tax rate in order to allow the tax breaks for those who do contribute more than the average. Where is the fundamental fairness in this?

Any higher income earner (and by “high” I only mean perhaps $75,000 or more) who does not have a pension plan would have to set aside perhaps 25% of their gross income in order to make use of all the tax-assisted plans. Otherwise they are being forced to subsidize those who maximize these tax-assisted plans. The inescapable fact is that a only small minority of the population is able to fully maximize all of these tax-assisted plans including pension. They are clearly being subsidized by all those who cannot maximize these things.

Now these high income earners are themselves subsiding those in lower tax brackets. But let’s assume for a moment that higher tax rates on higher incomes is “fair”. It is an inescapable mathematical fact that those who have pension plans and/or can fully utilize tax-assisted savings plans are being subsidized by those with similar incomes who cannot or do not fully use these plans.

Personally I am one of the people who is being subsidized. But that does mean I think it is right. And with the new Tax Free Savings Account I am certainly finding it harder or impossible to completely maximize all of these things.

Inheritance – Neither a Getter nor a Giver Be…

Are you in a position where you expect an inheritance? Why should you expect it? You’re a competent adult right? You’re capable of looking after yourself, right? Your parents don’t really have “excess” wealth do they? I mean do they really have no use for their own wealth? How do you know it won’t be needed for private medical treatments and senior care at some point? Shouldn’t you encourage you parents not to think about leaving any money? Their days of giving you money should be over by now, right?

Of course if you do get or have received an inheritance then of course you should accept it gladly. But I just don’t think anyone should think they are in any way entitled to an inheritance. Parents should be told that there is no expectation of an inheritance and that they should use their money as they see fit and hopefully for their own comfort and enjoyment.

Are you in a position to think about what inheritance you will leave to your kids? Refer them to the above. I don’t think children should be expecting inheritances. Especially not when they can on average expect to be over 50 when their parents pass on. Surely by then they are capable of looking after themselves. Isn’t planning to give an inheritance to an adult child a vote of non-confidence in that offspring? If you do plan to leave an inheritance, it might make sense to make it a surprise. The impact of expecting, or feeling entitled to, an inheritance is not likely to be a positive one.

Okay, But How Can We Make Some Money?

Well enough editorializing, how about some ideas to make money?

Warren Buffett teaches that a way to make money is to buy and hold the best pieces of “corporate (North) America” and to buy them when they are available at attractive or at least at reasonable prices. (Yeah, I know, people make fun of buy and hold, but Buffett’s done “okay” by that method). Identifying companies that are among the best and that will stay that way involves either finding someone who can select those companies for you or learning enough about some predictable type business so that you can select them yourself. For example you might feel that you understand Apple well enough to conclude that it is a great company and likely to stay that way.

At that point a further step is required. You or the advisor you are following must be able to form a conclusion as to whether Apple is selling at or below a reasonable price. Even for great companies, you don’t want to pay such a high price that it is the seller of the shares that makes the big return, while you make a small return due to over-paying for an asset. (Even a golden goose has some finite upper value that could be paid if a reasonable return is to be made).

Buffett also has said that if you can’t pick the right individual stocks then you will do perfectly well in the long term if you invest in a broad index like the S&P 500 (as long as you don’t pay too high of a management fee for this). And he has said this consistently all his life and as recently as early 2010.

By reading the material on this Site and by reading other high-quality investment analysis you can build your own expertise in selecting stocks and making judgements about whether or not they are priced at reasonable values.

Also we have a subscription service where we share our analysis of a selected group of companies. So far we have beaten the market nine out of our first ten years in existence. But we make no guarantees about the future. (And no knowledgeable stock investor would ask for a guarantee, since any such guarantee is impossible and would be a big red flag for a scam situation).


Shawn Allen, President
InvestorsFriend Inc.

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