An Incomprehensible Retirement

As our society discovers and creates, we must cope with our combined knowledge growing faster than our individual capacity to know things. Our solution - thus far - has been to specialize. When what is known expands, each individual becomes responsible for less breadth and more depth.

Back in the olden days there was only one kind of computer scientist. Before that there was only one kind of car mechanic. And even before that there was only one kind of doctor, who was also a barber. We used to know a lot less about cutting hair.

My job involves pushing bits around in a computer using abstractions that other programmers have provided me with. It’s pretty specific, but with the money I make I can pay Claire to fix my bicycle after I run it into something. The system works: I can spend my time being good at programming and Claire can be good at running a bicycle shop.

I should also probably save some of the money I make for retirement.

Retirement planning progression

I think that it would be reasonable to assume that as time goes on people are required to take a much less participatory role in planning their retirement. The financial market constantly increases in complexity, and is about as relevant to most people’s interests as animal husbandry. What we find is a little different.

Back before social safety nets made us all weak and pathetic, the way you prepared for old age was by having a big family. The idea was that your children would take care of you when you got old, as you had done for your parents. This works pretty well, but there are flaws.

Raising a big family and maintaining the social mores that require them to take care of you is complicated. It’s also much more viable in an agrarian society than an industrial/post-industrial one. So this inevitably went out of style as we moved into more urban environments and started having fewer kids.

Next up, we have pensions. These are way simpler than that last method. A pension is a contract that entitles you to be paid a certain amount of money regularly, usually until you die. Generally, you earn a pension by working for some number of years.

This ALREADY sounds great. Work for X years, get Y dollars every month. Someone else takes care of the details and I get a regular check.

If pensions were so simple and easy, what replaced them must be excellent.

The current way to retire comfortably

Right now the major retirement buckets my money can go into are an IRA or a 401k. The IRA and 401k both have Roth varieties that change how taxes are applied to them and… maybe I should make a list…

• IRA: Several varieties exist that determine how contributions interact with taxes. The type determines whether or not you can withdraw the principal before retirement age without penalties.
• The maximum yearly contribution one can make to an IRA changes every year - it’s about 5 grand right now - but is significantly less than you need to save to safely retire.
• After my income reaches a certain level, I may no longer contribute to an IRA.
• 401k: Set up by employers who will sometimes match your contribution up to a certain percentage of your salary. Their contribution may vest over time.
• If I do not put my retirement into one of these “tax advantaged accounts” then my earnings can be taxed as capital gains or regular income depending on how I invest.

Picking the right bucket to put money into will involve thinking about what your tax rate is now and whether or not you expect it to be lower or higher when you retire. There are pages and pages more that I could write about the differences between these things, but you get the point: these are not simple decisions.

How much money do I put in?

Do you have a good grasp of compound interest? Good! Get your calculator out because by the time you retire you’re going to want to have eleven times your annual pay saved up.

It also helps to not retire too close to a major “financial event” like the one in 2008.

Not making money yet

Once you have your money in an IRA or 401k, it’s still just cash until you invest it in something. This means that it’s purchasing power - what you can get for it - will be constantly reduced by inflation. Currently, the government tries to get inflation to be around two percent. The FED wants you to believe that what costs $100 today to cost $102 a year from now.

The problem with inflation is that there is not a standard way to calculate it. Goods fluctuate in value in relation to each other as well as in relation to the dollar. The number of candy bars you can exchange for a gallon of oil is not going to be the same a year from now. So, we must take as many things that can be bought into account as possible before we arrive at that one inflation number. As you can imagine, different people have different ideas about how to do this.

What’s important to note is that the government is incentivized to report as low of an inflation number as possible and to keep real inflation as high as tolerable. Why?

• The government sells a special bond that pays out interest based on the current rate of inflation. As the reported rate of inflation rises, so do the payments it has to make.
• The government owes more dollars than are owed to it. By making the dollar less valuable, we lower the amount of things that our national debt represents.

To combat this erosion of my money and secure a happy retirement, I must invest it in something that will appreciate in value faster than the rate of inflation. Significantly faster, preferably. Unfortunately, the things that grow in value quickly are also prone to shrinking in value quickly. Very unfortunately, it’s pretty hard to know how likely some assets are to grow or shrink quickly.

Ok, so what do people usually invest in?

• Mutual Funds: this is pretty common because your 401k provider will give you a big list of these to choose from. These are all managed by some people who take a cut of any profit you make.
• Bonds: You can buy these from a government or company. They pay a set amount over a number of years.
• Index funds: Funds designed to track the performance of a bunch of stocks lumped together. These funds have low fees.
• Individual stocks: people who think they can do better than the overall market sometimes invest in individual businesses. This is very, very dangerous.

There are many more options, but these are the most common.

That bond thing looks pretty foolproof

It does, but the FED is currently creating money out of thin air and using it to purchase bonds. This is called quantitative easing, or QE for short. This might not make sense to you,but you need to know about it to understand this next bit.

QE raises demand for bonds, which reduces how good the payout for bonds has to be for them to be bought. Because QE has been going on for a while, investing in bonds before it’s over is a really bad idea since you will be getting such a bad deal (The FED is bidding against you).

This environment is why a Apple - a technology company - can get investors to buy 30 year bonds with tiny interest. The bond market is that bad.

Well that’s really complicated…

Congratulations for making it this far into the article. That was a lot of stuff, wasn't it? Pretty dry, huh? I've been reading books about this for a while now - I want to have teeth when I’m old - and I can’t honestly tell you I feel secure about the decisions I’m making when it comes to my retirement.

This stuff isn't easy. In fact, it makes me long for the days of pension funds. Unfortunately, those have rapidly gone out of style, and few companies continue to offer them. The reason for this is that pension funds require a safe, steady source of income to form the base of their capital.

For a while, that base was primarily composed of bonds. That strategy is no longer viable. Now that bonds have become such a bad investment - see three paragraphs up - pension funds of big companies are running into big trouble. Goldman Sachs recently gave a great presentation about how screwed pension funds are (link). Parent companies are having to pour more and more money into their funds to keep them afloat.

This is the point where things stop making sense to me. Pension funds have full-time professional investors managing them, but their goals are no different than those of the average person saving for retirement. They are both trying to ensure a steady flow of money to one or more people after those people retire.

If professionals who benefit from the economies of scale cannot reasonably be expected to provide me with a stable retirement without outside intervention, how can I be expected to do that for myself?

Everyone get angry

The occupy movement rallied against what they perceived to be a rigged game: a financial system that required their participation but did not offer them a seat at the table. Then they went home - maybe because the weather got bad - and were quickly dismissed by the collective psyche.

Even so, if any part of that movement should remain, let it be the indignation aimed at any group that takes their sliver of accumulated human knowledge and turns it against all others.

We have arrived at a market where the vast majority of effort goes into playing a less than zero sum game for material excess with risks that no one may fully understand; this is the arid earth where we must plant our dreams of a comfortable retirement.