I don’t know Robert C. Merton personally. Reading his biography, he seems smart and accomplished. He holds degrees from Columbia, Caltech, and MIT. He was also awarded the Nobel Prize in Economics in 1999, which was right after his hedge fund, Long Term Capital Management, almost destroyed the U.S. financial system.
Sometimes smart people make bad decisions. When it affects their own lives, that’s too bad. When it affects the rest of us, we need to stop it before things get out of hand.
Right now Mr. Merton, along with co-author Arun Muralidhar, is touting a solution to the looming American retirement crisis. He has introduced an idea for a new sort of bond that provides income.
Unfortunately, his solution isn’t just unworkable for future retirees. It would also redirect capital away from businesses and to the government.
There is a better way.
Google the words “American retirement crisis” and you’ll get millions of hits. There’s no shortage of research pointing out the problems we will face as boomers retire.
Bloomberg reports that Americans 55-64 years old have a median amount of $14,500 in retirement savings, meaning half are above that number, and half below.
If that’s not enough to make you gag a little bit, consider that the average Social Security monthly benefit check is a paltry $1,300, and just over 30% of all recipients rely on that check as their sole source of income.
Mr. Merton and Mr. Muralidhar seem to think the problem is that Americans are focused on wealth accumulation, when they should be focused on replacing income in retirement. This misplaced priority has the typical Joe taking too much risk in his 401(k) or IRA, chasing stocks or buying questionable bonds. At the end of his working life, this average guy has precious little to show for his efforts, and no simple way of turning his small nest egg into a lifetime of income.
Their assessment is correct – Americans need to focus on income replacement instead of wealth accumulation – but it doesn’t start in the right place. If you’ve only set aside $15,000 to $25,000 for retirement by the time you’re 60 years old, it doesn’t matter what your focus is.
You don’t have enough money. Period.
Some people were bankrupted by medical costs or circumstances beyond their control (think job losses and foreclosures during the financial crisis). Some just didn’t save. No matter how they got there, it’s the taxpayers who will care for this group in their retirement years.
As for those that do save more than $20,000, the issue isn’t just developing a stream of income. It’s having confidence that the income will actually amount to something. They want to have enough money saved up to be able to afford a monthly income that is substantial. But what they’re not considering is the risk of outliving their cash.
If I have $100,000 at retirement and use it to buy an annuity that pays monthly income for the rest of my life, today I would get about $560 per month, with nothing sent to my heirs if I die tomorrow or in 40 years.
Most people have a problem with that trade off. Giving up control of $100,000 in return for less than $7,000 per year isn’t enticing. In fact, it turns out to be an estimated 3% rate of return, if I live 20 years as expected.
If I don’t make it 20 years, then the insurance company keeps the leftover funds. But if I live longer than expected, they have to keep paying me. If I build my own annuity out of bonds, then I’ve always got the risk that I’ll outlive my money because there is no institution taking on that liability.
Merton and Muralidhar think they have the solution. They recommend the U.S. government issue “BFFS,” or bonds for financial security.
I think they should be called, “BFFSO,” or best friends forever, sort of.
These bonds would be sold like ordinary Treasury bonds, but they wouldn’t mature in the normal way. Instead of paying interest and eventually paying a lump sum of principal, the bonds would pay off in a stream of monthly payments over 20 to 25 years starting at some point in the future chosen by the investor.
A 45-year old could buy a BFFS that started paying at 60, providing income to age 85. If he lives longer than that, he better hope that he planned well enough to buy more of the bonds with start dates at 65, 70, etc. These bonds are your best friend, but only if you don’t live too long.
BFFS have the benefit of paying off even if the original owner dies ahead of schedule, which is a plus. But what would happen if millions of retirees suddenly chose to buy a new class of government bond instead of traditional stocks and corporate bonds?
Demand for government debt would explode while other markets went quiet. This would drive key interest rates on government securities even lower, while taking capital away from the private markets, where it’s typically used for R&D, corporate expansions, etc.
Overall, the idea won’t motivate savers to put more money aside, because it doesn’t frame the problem correctly.
We have to get savers to consider a basic question. What matters most: a pot of gold you control, or enough monthly income to support your standard of living? After that, the right tools to address the problem already exist. There’s no reason to direct more cash to the U.S. government.
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