The Mutual Fund Bite
But ordinary 401(k) and mutual fund investors don’t reap the full benefit of those long-term results, Bogle said, because of the large bite taken out of 401(k) plans by the financial industry—the mutual funds and banks that manage 401(k) accounts. According to Bogle, their fees and transaction costs average 2 percent a year. Subtracting that from the average 5 percent gain leaves individual investors with a net gain of 3 percent. Over the long term, the mutual fund bite has a compounding effect. That means, Bogle said, that over forty years, the projected gain from $1 to $7.04 gets cut way down—to $3.26.
“Where did the nearly $4 difference go?” Bogle asked. “It went to Wall Street [in fees]. So you the investor put up 100 percent of the capital. You take 100 percent of the risk. And you capture about 46 percent of the return. Wall Street puts up none of the capital, takes none of the risk, and takes out 54 percent of the return.”
That is why Bogle is a staunch advocate of stock index funds, a basket of diverse stocks combined in an index to represent the whole market. Index funds cost the customer much less, Bogle pointed out, because the index has a fixed portfolio and does not require a fund manager to trade in and out of stocks. “You can buy an index fund for one-tenth of 1 percent,” he said. “No turnover expense. No sales load or commission. You get 4.9 percent investment gain out of the 5 percent growth. You get $6.78 out of that $7.04 instead of seeing most of it go to the financial industry.”
How Much to Save?
On a personal level, the main reason average Americans do poorly with 401(k) plans is that they don’t invest enough, largely because they have no practical idea of how much they will need for their retirement years. Typically, people underestimate their longevity and how many more people are living into their eighties and nineties. Long life is the upside. The downside is the money it takes to pay for all those extra years.
Most people are shocked to hear the estimates of financial experts of what they will need. Based on the actual spending of current retirees, EBRI has developed the following sliding scale: To best secure the likelihood of having enough money to last over a lifetime, people who earn $50,000 to $100,000 a year should build a retirement fund seven to thirteen times their highest earnings, in order to have enough money to last their lifetimes. Using a midrange, that translates into a $500,000 retirement fund for a $50,000-a-year employee and a $750,000 fund for a $75,000-a-year worker.
The Boston College Center for Retirement Research sets slightly lower targets—a savings of $300,000 for a $50,000-a-year earner; $550,000 for people making $75,000; and nearly $800,000 for people making $100,000. But their numbers, unlike EBRI’s, leave out medical costs, which can run another $200,000 for a couple over sixty-five. Either way, those professionally developed targets are five to ten times greater than the 401(k) balance of middle-income Americans on the lip of retirement.
Most Plans Are “Half What They Need To Be”
Take Rich Kidner, a wry, friendly computer geek who handles customer help calls for Perot Systems, the software company founded by Texas billionaire Ross Perot.
Since he joined Perot in 1992, Kidner has regularly contributed to his 401(k) plan, recently about $5,000 a year, out of his yearly salary of $75,000. By late 2007, Kidner’s balance had hit $149,000, but then, he said, “I got hit like everyone else, and it fell to $111,000.”
Still, that sounds pretty good, and Kidner was feeling very fortunate because he kept his job when Perot sold out to Dell and the company health plan paid out $175,000 for his major heart valve operation and recuperation. Now sixty and back at work, Kidner, who is an avid golfer, dreams of retiring at sixty-five and traveling to major golf tournaments worldwide.
But he was stopped dead in his tracks when I asked how he could afford to quit five years from now when the financial experts say he’ll need a nest egg of $550,000 to $750,000 to retire on—five or six times what he then had.
“Where am I going to get that kind of money in five years?” Kidner gulped. “I’ve saved my whole life for retirement, and I can’t get near that kind of money.”
The hard truth, according to several experts, is that building the nest egg you need takes much more ambitious savings than virtually any 401(k) plan envisions for employees below executive levels. The best plans typically let employees sock away 6 percent of their pay each year and match it with 3 percent from the company, for a total of 9 percent.
But the experts at EBRI told me 15 percent a year should be the combined target. Vanguard founder Jack Bogle also said 15 percent. Brooks Hamilton, the corporate pension consultant, put the figure higher—15 to 18 percent. Most plans, said Hamilton, “are half what they need to be.”
The Nation’s Retirement Fund Deficit—$6.6 Trillion
Add it all up—what people really need when they turn sixty-five compared with what they have in their 401(k) plans, IRAs, and the other savings—and you get a price tag on the nation’s retirement shortfall. Anthony Webb, research economist at Alicia Munnell’s Boston College Center for Retirement Research, did just that. He calculated what he called “the national retirement income deficit” in 2010. It came to $6.6 trillion.
“That $6.6 trillion is a call to action for us as a country,” said Webb. “It’s telling us that the whole system isn’t working.”
What’s more, Webb’s figure did not include the enormous shortfalls in corporate and public pension funds, both of which are vastly underfunded. In 2009, the PBGC, the federal agency that oversees business pensions, estimated the corporate pension shortfall at roughly $500 billion. City and state pension funds are estimated to be even deeper in the red—$1.5 trillion or more.
Anyone faced with paying those bills is in shock. In 2011, pension fund deficits fueled controversy over public employee pensions in Wisconsin, Ohio, New Jersey, and Indiana. Unions had won pensions for public employees to retire at fifty-five, even though life expectancy was rising. The burden became impossible for taxpayers. Government officials, like corporate CEOs and CFOs, had been overly optimistic about pension plan investment returns, and that produced massive red ink in state and city budgets. Even union leaders conceded the need to raise retirement ages and to scale back benefits.
“Our nation’s system of retirement security is imperiled, headed for a serious train wreck,” Jack Bogle warned Congress.
The 401(k): Steady Savings or Roulette Wheel?
The 401(k) system has come under increasing fire from some of its original architects, such as pension consultant Ted Benna, widely called the “father” of the 401(k) system for his role in persuading the Reagan administration to extend the original executive 401(k) deferred compensation plan to the rank-and-file.
“Now this monster is out of control,” Benna told Smart Money, the Wall Street Journal blog, in November 2011. “I would blow up the system and restart with something totally different…. We’re throwing tons of money away trying to teach participants how to become skilled investors—we said, we are going to make people smart and savvy enough to make the right investment decisions, but it just hasn’t worked.”
In Benna’s eyes, the beauty of the original 401(k) concept was that it offered only two options—a guaranteed income fund and a stock equity fund. The problem with the modern 401(k), Benna said, is that it offers too many options and it has baffled average Americans who are not savvy at making sound investment decisions.
Financial professionals such as Thomas C. Scott, CEO of Scott Wealth Management and author of Fasten Your Financial Seatbelt, report that the public yearns for the predictable security of the old lifetime pensions. Scott cited a Fidelity Investments mutual fund survey, which found that “85 percent of investors 55 to 70 years old placed greater importance on a guaranteed monthly retirement income than on above-average investment gains.”
Advocates of 401(k)-style plans such as David Wray, president of the Profit Sharing/401(k) Council of America, assert that the 401(k) system can be made to work if average
employees can be pushed to stick to their plans over the long run. Given recent innovations such as automatic enrollment and “target date funds,” Wray contends that the 401(k) system has been improved. Target date funds do the long-term financial planning through an investment formula targeted to an employee’s projected retirement date, periodically reallocating investment objectives to match the investor’s age.
But skeptics such as Eric Schurenberg, editor in chief of CBS MoneyWatch, consider the 401(k) plan inherently risky. Instead of being a steady, reliable savings plan, Schurenberg said, the 401(k) has become like a roulette wheel that “randomly creates winners and losers.” The accident of market timing, Schurenberg wrote, can demolish the best-laid plans. “It all depends on when in your working life the inevitable market downturn falls,” he said. “If early, you’ll build your nest egg by buying cheap assets and retire rich. If late, you’ll find your life savings decimated when it’s too late to rebuild.”
The End of Retirement?
The poor 401(k) track record to date, said Alicia Munnell of Boston College, has left individuals with three options: Save more, work longer, or live on less. “They’re all unattractive,” Munnell admitted, “but the least unattractive is working longer.”
It’s already happening. The official retirement age under Social Security is creeping upward, from sixty-five to sixty-seven, and it will go higher, as it should, to mirror increases in lifetime longevity. Surveys confirm that more people are coming to the tough realization that they will need to keep working during their “golden years.” In late 2010, nearly three out of four Americans said that they expect to work well into their retirement years, because they know their financial nest egg won’t be nearly enough.
Older workers (fifty-five and up) are already growing as a share of the total workforce, from 12 percent in 1999 to 19 percent in 2009 and likely to be 25 percent a decade from now. Even among people seventy-five and up, the number with jobs is rising. In 2011, about 7.5 percent of that group were working, with predictions of 10 percent or more by 2018.
“Baby boomers will be facing a very different kind of retirement life than their parents …,” observed Teresa Ghilarducci, a senior pension economist at the New School for Social Research in New York City. “The only way they can do it is if they work. The only source of income to retirees—and I understand the irony in what I’m just going to say—the only increasing source of income to retirees is from work….
“So what is the meaning of the word retirement, if the only way you can live in retirement is to work—or look for work?” she asked. “The answer is, there is no meaning to retirement anymore. We’re now shifting from lifetime pensions to lifetime work. It’s the end of retirement.”
Is There a Better Way? Ask Nebraska
In the face of that bleak assessment, retirement experts like Alicia Munnell and Brooks Hamilton suggest there is a better way for people to do their retirement saving. Most average Americans, they argue, would be much better off giving up do-it-yourself investing and putting their savings, with company match, into a company-wide investment fund run by professional financial managers. People would have individual accounts—their share of the company fund based on their contributions and longevity. But their funds would be locked in until retirement, and pros would manage the investing.
The state of Nebraska actually ran a test of this concept, using two different retirement plans. Starting in 1964, one group of Nebraska’s state employees went into a traditional, professionally managed lifetime pension plan, and another group went into a 401(k)-style plan funded and run by employees. Both plans set mandatory participation and contribution levels. Both got the benefit of a generous, steady 6 percent state employer match.
About a decade ago, retirees in the do-it-yourself plan complained that their retirement funds were insufficient. The state legislature demanded an outside study, which examined results from 1980 to 2004, one of the best periods for stock investing in U.S. history. The study delivered the unambiguous finding that the pooled funds in the professionally managed defined benefit pension had done far better than the 401(k)-style funds. With pooled assets and professional management, “the average rate of return for the last twenty-plus years has been over 10½ percent,” reported Anna Sullivan, executive director of Nebraska’s state retirement funds agency. In the employee-run plan, she said, “the average rate of return was somewhere between 6 and 7 percent.”
That may not sound like much of a difference, but it is huge. Compounded over twenty years, that 4 percent earnings gap meant that the retirement accounts in the professionally managed program were double the size of the do-it-yourself accounts. The study also confirmed the retirees’ complaint—that the 401(k)-style plan left them short of retirement funds. “It’s just not adequate,” Sullivan reported. So Nebraska killed its 401(k)-style plan and put everyone into a state-run lifetime pension.
A New Nationwide Plan?
“This is a national problem and we have to come up with a national solution,” asserted Karen Friedman, executive vice president of the Pension Rights Center, a public advocacy group.
“We need a new tier of retirement savings,” echoed Alicia Munnell. “The 401(k) system has proven to be totally inadequate. It can’t do the job. I don’t think the answer is to throw it away. But we need a new program with pooled assets, mandatory contributions, funds professionally managed, and assets locked up so that people can’t get at them until they retire.”
Jack Bogle advocates something like the Nebraska model on a national scale: converting people’s savings from their 401(k)’s, IRAs, and other plans into personal retirement accounts with one big new U.S. retirement fund run by America’s best professional money managers. These experts would be picked and overseen by a new Federal Retirement Board. Bogle urges that the plan include the 50 percent of Americans whose employers currently offer no retirement plan.
Teresa Ghilarducci, the pension economist from New York, has proposed a similar idea but with one important wrinkle: Participation by all employees and all employers should be mandatory, with an annual contribution of 5 percent of pay, shared equally by employers and employees.
Any reform of this nature faces an uphill battle as long as Corporate America, the mutual funds, and the banks are reaping huge financial benefits from the current 401(k) system and while politicians at the state and federal levels are pushing public employees away from the old lifetime pensions into 401(k)-style programs.
For a people-first program, it will take a populist revolt among baby boomers—the people who face possible poverty in retirement, unless the current system is changed.
CHAPTER 13
HOUSING HEIST
PRIME TARGETS: THE SOLID MIDDLE CLASS
Right here in America, if you own your own home, you’re realizing the American Dream…. That’s why I’ve challenged the industry leaders all across the country to get after it … by achieving the goal of 5.5 million new minority home owners.
—PRESIDENT GEORGE W. BUSH,
June 2002
I didn’t think I was in an economic position to buy a house. I didn’t think I made enough money…. It was a nightmare…. I was angry—angry at myself because I shouldn’t have believed the promises they made to me…. They knew I could not afford that loan.
—ELISEO GUARDADO,
subprime borrower
The banks are playing to brokers who specialize in driving people into loans that people don’t understand…. They take a product that was exotic and move it to the category of a weapon—seriously. These loans go from being an exotic product to a hand grenade….
—KATHRYN KELLER,
mortgage broker
WHEN YOU THINK OF THE HOUSING CRISIS and millions of Americans being foreclosed out of their homes, you don’t imagine a bright, successful thirty-year-old like Bre Heller. When I met her, Heller was still reeling from the forced sale of her home in Orlando, Florida, stuck with a mountain of debt and furiou
s at her bank. She didn’t seem like a typical victim. She’s street smart, quick as a whip with numbers, and a picture of cool composure. From the knowing way that she marched me through her loan documents, it was clear that she understood home finance.
Even so, she got stung. She got locked into a mortgage loan that she did not qualify for. By the time it was approved, she couldn’t afford it and did not want it. So on October 22, 2008, with the ominous shadow of foreclosure looming over her $513,000, four-bedroom home, she emailed the Florida attorney general’s “fraud hotline.”
“I am a victim of predatory lending practices executed by Washington Mutual Bank in November 2006,” Heller told the attorney general’s office, “and would like to know the necessary steps to filing a formal complaint. I do have a full breakdown of fair lending practices that were violated, inclusive of:
“1. Being steered into a higher interest rate than necessary.
“2. Structuring loans with payments borrowers cannot afford.
“3. Falsifying loan applications in regards to income to qualify for a loan.”
What made Bre Heller’s case so striking was that her mortgage lender, Washington Mutual Bank (WaMu), was also her employer. For almost four years, Heller had been a very successful loan account executive in the white-hot Florida home loan market for the Long Beach Mortgage Company, a subsidiary of Washington Mutual.
So in her email to the Florida attorney general, Heller was accusing her own bank of locking her into two loans totaling $513,525 by falsifying her loan application, downgrading her to a below prime loan, and charging her a higher rate of interest—all without telling her. It was a story familiar to legions of middle-class Americans.
Who Stole the American Dream? Page 20