Retirement and the Magic of Investment Returns

Compound interest, which urban legend has Albert Einstein citing as the most powerful force in the universe, is a magical thing. Put aside a few dollars, do it regularly, and – Shazam!! – before you know it, you’re a millionaire.

Well, maybe not exactly “before you know it.”

Could take a few decades. Maybe more.

But who cares?

I do, for one. You will soon, I think.

After decades of railing away at the grievous losses savers suffer when they pay high investment fees, I’ve started to worry about something else.

What could be worse than the klepto-managers of Wall Street?

Low to nonexistent returns on investment and savings.

Stay with me while we dissect what happens in one of those glorious trips to your first million. Suppose you’re 25 years old, employed, and capable of putting aside $500 a month in your 401(k) plan. We’ll also suppose that your plan costs a relatively low 0.75 percent of assets a year.

And just to be very reasonable, we’re going to assume that you’ll be earning a gross return of 7.25 percent a year. (That, by the way, is the current assumption of the pension plan for the Texas Teachers Retirement System, and it’s in the middle of return assumptions by statewide public pension plans.)

Where will you be at age 65?

What’s In Your Account?

Yup: You’ll be a 401(k) Millionaire. To be precise, the $240,000 you put aside over 40 years will have grown to $1,141,809. That’s before taxes, of course, but few will say it’s a dull amount of money.

Now examine what went in and out:

— You put aside $240,000 in painless pre-tax income.

— Your investment accumulated to $1,141,809, before taxes.

— The investment managers, had they invested their fees as you did, would have made $266,433. (They didn’t actually get that in fees, but they would have accumulated to that much if invested. It’s interesting that even at a relatively low fee rate, their fees took more than you made in contributions.)

— Your friends at the U.S. Treasury will collect $137,017 if we make the benign assumption that you are blessed with a retirement tax rate of 12 percent.

— You’ll have a net of $1,004,792 in after-tax spending power.

— You’ll have $764,792 in accumulated investment return in addition to your original $240,000.

— Still better, that additional $764,792 will earn interest, dividends and capital gains for the rest of your life. That could be another 20 years. Or more.

You could, of course, come out of this with still more money by investing in the low-cost index funds. I figure that would increase your stash by another $217,000 or so, but what’s a small fortune between friends? Don’t worry, be happy. You’re a millionaire!

Without Returns It’s All a Dream

Except for one thing: This is whole thing is a fantasy.

Today, every public and private pension in America, as well as every person saving for his or her eventual retirement, is threatened by a World Without Yield. Those threatened include all those graduating into the highest unemployment rate since the Great Depression.

Retirement – its very concept – simply doesn’t work when returns fail to make the final accumulation a healthy multiple of the amount actually saved.

That happens only when investments have returns.

As I write this, the yield on 30-year U.S. Treasury obligations is 1.40 percent, while the yield on a six-month Treasury bill is 0.14 percent. Unless you count on deflation for the next 40 years, it’s looking like there is no real return on any money you invest in any secure financial institution.

We can, of course, invest in common stocks. Maybe we can do better with them. Or not.

Now let’s imagine what it would take to retire in a world without investment returns. It’s not a complicated problem. We’d need to save enough in the 40 years we might work to pay our way through the 20 years that we are likely to live in retirement.

Lower returns mean we need more savings

We’ll start with a fairly aggressive saving rate.

• If you save 10 percent of your income, you’ll accumulate four years of income, or 4.4 years of spending for your retirement. (Since you’ve saved 10 percent, you’ll need only 90 percent of income to spend in retirement.)
• If you save 20 percent of your income, you’ll accumulate eight years of income, or 10 years of spending in retirement.
• If you save one-third of your income, you’ll accumulate 13 1/3 years of income, or 20 years of retirement spending.

As you’ve probably already guessed, very few people save at such rates. They are mutually exclusive with our consumer society.

Welcome, citizen, to the “You Can’t Get There From Here” Economy.

This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Photo by Johannes Plenio from Pexels

(c) Scott Burns, 2020