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Don't Count On Your 401(k)

By Mark Gimein
Sunday, May 17, 2009

"Our nation's system of retirement security is imperiled, headed for a serious train wreck. That wreck is not merely waiting to happen; we are running on a dangerous track that is leading directly to a serious crash that will disable major parts of our retirement system."

-- John Bogle, Feb. 24

If several years before the financial and credit crisis hit, someone had told you that the housing market was preposterously overvalued and derivatives were headed for cataclysm, would it have been worth paying attention to? The answer's pretty clearly yes, ain't it? Of course, some of the best minds in finance -- from Warren Buffett to Yale housing economist Robert Shiller -- did. It's just that hardly anyone listened.

Now there's another crisis building. It's just as big. Again, some of the best thinkers in the financial world are warning about it. (Yes, Buffett's one of them.) And yet again, as is often the case with gathering storms, most of us are doing our best to ignore the warning signs.

Americans lost almost a quarter of their retirement savings last year. Yet even if there were no market drop, we'd still be facing a disaster in the making.

The urgent lines at the top of this story come from John Bogle, founder of the Vanguard group of mutual funds and father of the low-cost stock index fund, the simplest and most cost-efficient tool yet devised for individuals investing in stocks. Of all the people who've thought longest and best about individual investing, Bogle has to rank near the top. For decades before the financial crisis ripped open the country's retirement accounts, Bogle was tirelessly warning people away from their brokers' fads and follies.

Bogle's voice is now one of the loudest and most cogent of those calling for a rethinking of American retirement. His words are from remarks that Bogle made to a congressional panel looking at the security of American savings. Like much of what is said about retirement, Bogle's comments passed by without much attention.

The bad news from Bogle is that the way it's set up now, the 401(k) isn't the panacea that policymakers on all sides of the spectrum hope it will be. What's wrong with the 401(k)?

-- Simply having a retirement account is not enough. Much of the discussion of the past year has focused on getting workers to open 401(k)s. The problem is that the big majority of retirement accounts don't really hold nearly enough money.

According to Bogle's numbers, the median IRA has $55,000 in it. By his calculations, that's enough to provide a steady income of $2,200 a year -- less than $200 a month. That's it.

And 401(k)s? The typical 401(k) holds only $15,000. Bogle argues that to reach the level of income they hope for in retirement, Americans need to put 15 percent of their earnings in retirement accounts for their entire working lives. Very few do.

-- One of the biggest differences between individual accounts and traditional pension plans is that they transfer what Bogle calls "longevity risk" from pension funds to individuals. What that means in practice is that you need to save more -- a lot more -- in your account than a pension plan would to cover the chance that you'll live to a very old age.

-- We all know the financial advice about putting retirement assets in safe investments as we grow older. But in practice, we don't come close to following it. The big majority of retirement-fund assets are in equities. And it doesn't get much better for people approaching retirement: According to Bogle, 30 percent of them have 80 percent of their IRA investments in stocks.

Clearly, finding ways to nudge people to put more money into retirement accounts is part of the answer. But it's only a small part. It does nothing for longevity risk, and nothing to distribute investment risk. Pension funds did that: If you happened to retire the year the market crashed or you lived to be 90 years old, that was okay, because your risks were shared with people who retired in other years or failed to live as long.

Bogle points to several tools -- the creation of annuities that would work a lot like pension plans to level investment and longevity risk -- that would help give Americans the tools they need to manage their retirement.

But developing those tools and making them widely available right now just isn't on the political agenda. And Bogle warns that we shouldn't expect them to come from the big financial companies.

We're already witnessing the beginnings of a retirement catastrophe now: You can see it if you look at the growing number of older Americans who have kept working into their 60s and 70s or gone back into the workforce.

Without a dramatic change not just in the amount of money that we save but in how we save, it will get much worse.

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