Field Work

January 12, 2021

Something remarkable is happening in the economics profession. Top researchers in the field have begun arguing for policies to alleviate growing U.S. income and wealth inequality.

For decades, inequality wasn’t taken very seriously by economists. But that view “has changed dramatically,” said James K. Galbraith of the University of Texas at Austin, who moderated a Zoom panel at the annual meeting of the Allied Social Science Associations last week.

Inequality, Galbraith said, has “become one of the most important questions economists face.”

And COVID-19, argued Nobel laureate Joseph Stiglitz, a panelist, “has brought out very forcefully the nature of the inequalities in our society” and has “exacerbated those inequalities.”

The pandemic’s effects include larger increases in unemployment for low-wage workers, who are disproportionately Black and Latino and often work for small businesses devastated by efforts to suppress the virus. In addition, front-line workers like home health aides and meat-packing workers are being exposed to the virus but don’t always have paid sick time. There are also growing concerns about the longevity gap and about a widening educational gap between students from poor and high-income neighborhoods resulting from online learning.

The economists, having agreed inequality is a problem, identified the myriad forces driving it. They range from the persistent segregation of Black and white neighborhoods to the ability of the wealthy to invest and accumulate more wealth, while wage workers can barely get by. In a cutthroat global economy, the decline of unions has also stripped workers of their ability to bargain with employers for higher wages, they said.

Another panelist, Teresa Ghilarducci, brought attention to the inequality that exists among retirees. This can be seen in the downward mobility many people experience after they retire and can no longer support the standard of living they had while they were working.

To address these complex problems, the economists said a comprehensive policy agenda is needed that includes beefing up Social Security benefits – the great equalizer – for disadvantaged retirees, more taxation of inheritances, educational equality at the preschool through college levels, sturdier social safety nets, and new labor rules that give workers back some of the power they have lost.

Another panelist, Jason Furman, former chair of President Obama’s Council of Economic Advisers, agrees that an array of policies will be required to combat inequality. But he also argued that the two major relief bills Congress passed last year – a total of $2.9 trillion – probably reduce inequality. …Learn More

November 17, 2020

When David Marotta is investing his clients’ money in mutual funds, he scrutinizes the fees.

To demonstrate why fees are so important, Marotta charted the fees and 10-year returns for dozens of index funds in the Standard & Poor’s 500 family. Since these funds all track the same index and their performance is roughly the same, the fees will largely determine how much of the return the investor keeps and how much goes to the mutual fund company.

“The larger the fee the less that it performs. It’s kind of a straight line,” said the Charlottesville, Virginia investment manager. “Anytime we’re picking a fund” for a client, “we’re trying to find the lowest-cost fund that we can find in that sector.”

The fees for the S&P 500 index funds he analyzed using Morningstar data ranged from one-tenth of a percent to 2.5 percent of the invested assets.

The issue of fees versus performance is more complicated for actively managed investments, which sometimes have strong returns that justify paying a higher fee. But in any investment, the true measure of how it’s doing is the after-fee return.

However, deciphering mutual fund fee disclosures can be extremely difficult for do-it-yourself 401(k) and IRA investors – and that is by design.

An analysis of S&P 500 index funds identified numerous narrative techniques in mutual fund documents that confuse investors. The researchers – from the University of Washington, MIT, and The Wharton School – evaluated each fund’s disclosures and showed that funds with more complex explanations of their investment holdings and fees also have higher fees. The researchers call this “strategic obfuscation.”

The study, which covered the period from 1994 through 2017, illustrated this complexity with two firms’ descriptions of their S&P 500 index funds. Schwab’s one-sentence summary gets right to the point: “The fund’s goal is to track the total return of the S&P 500 index.” This fund’s annual fee is 0.02 percent of the assets.

Deutsche Bank’s disclosure is more complicated for a few different reasons. First, the summary is three paragraphs and starts this way: “The fund seeks to provide investment results that, before expenses, correspond to the total return of common stocks…” …Learn More

Field Work

May 14, 2019

About a third of retired households end up relying almost exclusively on Social Security, because they didn’t save for retirement. Social Security is not likely to be enough.

To get Oregon workers better prepared, the state took the initiative in 2017 and started rolling out a program of individual IRA accounts for workers without a 401(k) on the job. The program, OregonSaves, was designed to ensure that employees, mainly at small businesses, can save and invest safely.

Employers are required to enroll all their employees and deduct 5 percent from their paychecks to send to their state-sponsored IRAs –1 million people are potentially eligible for OregonSaves. But the onus to save ultimately falls on the individual who, once enrolled, is allowed to opt out of the program.

More than 60 percent of the workers so far are sticking with the program. As of last November, about 20,000 of them had accumulated more than $10 million in their IRAs. And the vast majority also stayed with the 5 percent initial contribution, even though they could reduce the rate. This year, the early participants’ contributions will start to increase automatically by 1 percent annually.

The employees who have decided against saving cited three reasons: they can’t afford it; they prefer not to save with their current employer; or they or their spouses already have a personal IRA or a 401(k) from a previous employer. Indeed, baby boomers are the most likely to have other retirement plans, and they participate in Oregon’s auto-IRA at a lower rate than younger workers.

Despite workers’ progress, the road to retirement security will be rocky. Two-thirds of the roughly 1,800 employers that have registered for OregonSaves are still getting their systems in place and haven’t taken the next step: sending payroll deductions to the IRA accounts.

The next question for the program will be: What impact will saving in the IRA have on workers’ long-term finances? …Learn More

Field Work

January 31, 2019

It might be the most consequential issue baby boomers will deal with when they retire: did I save enough?

Vanguard’s free online calculator will estimate that for you, using the same sophisticated technique financial advisers charge hundreds of dollars to provide.

The user-friendly calculator uses 100,000 of what are called Monte Carlo simulations of potential future returns to the financial markets to arrive at the probability that a household’s invested savings will last through the end of retirement. To get to this number, older workers enter their information into the calculator – 401(k) account balance, asset allocation, estimated years in retirement, and annual withdrawals – by moving around a sliding scale for each input.

The financial industry recommends aiming for a probability in the 80 percent range – 95 percent is overdoing it. In the end, however, your comfort level is a personal decision.

An important purpose of the calculator is to demonstrate how changes in the inputs can hurt one’s long-term retirement prospects – or improve them. One obvious example is increasing the annual withdrawal amount, which lowers the probability the money will last. To increase your chances, try a later retirement date.

The calculator is a lot of fun, but it has some limitations.

First, it’s no substitute for a detailed pre-retirement financial review. The other issues are primarily mathematical, and they boil down to the difficulty of predicting the future.

The calculator assumes, for simplicity, that a retiree withdraws the same dollar amount from savings every year to supplement Social Security and any pension income. But Anthony Webb, an economist at the New School for Social Research in New York, said this ignores the most important thing retirees should do to preserve their money: adjust the withdrawals every year, depending on how their investments have performed.

“If you encounter icebergs (bear markets), you should cut your spending” and withdrawals, he said. …Learn More

January 24, 2019

One thing really stood out in a recent study: the deterioration in Hispanics’ retirement prospects since the 2008-2009 recession.

Workers’ success at saving for retirement is becoming increasingly important to their financial security in old age. This puts Hispanic households at a clear disadvantage: they earn half as much as white households, which makes it that much more challenging to build retirement wealth by buying a house or saving more in their 401(k)s – two-thirds of Hispanic workers don’t even participate in an employer 401(k).

White Americans aren’t exactly in great shape either. Today,
48 percent of them are at risk of experiencing a drop in their standard of living after they retire – this is 6 percentage points higher than before the recession, according to a new study by the Center for Retirement Research. Black Americans are worse off than whites, though their situation hasn’t changed much over the past decade.

But 61 percent of Hispanic workers are at risk – a 10-point jump since the recession – the study found. A big reason is that Hispanic homeowners were hit especially hard by plunging house prices during the mortgage crisis in states like Florida, Nevada, Arizona, and California, where they are heavily concentrated. Their home equity values dropped 41 percent, a result of buying “houses in the wrong place at the wrong time,” the researchers said.

The loss of home equity has a big impact on retirees by reducing the amount they can extract from their properties by purchasing less expensive housing or taking out a reverse mortgage. (The researchers assume that when workers retire, they will use reverse mortgages.) …Learn More

Money Culture

November 1, 2018

The fact that the richest Americans are grabbing such a big slice of the pie isn’t exactly breaking news.

What is news is that Wall Street is getting nervous about it. Moody’s Investors Service, a private watchdog for the federal government’s fiscal soundness, has concluded that inequality has reached the point that it threatens a system already being strained by increases in the federal debt. But Moody’s also noted that inequality is contributing to slower economic growth, which further aggravates inequality.

The high level of U.S. inequality today “sets us apart” from Canada, Australia, and several European countries, Moody’s said in an October report, “Widening Income Inequality Will Weigh on U.S. Credit Profile.”

Moody’s central concern is how inequality will affect the federal budget. When the economy slows in periods of high inequality, there are more lower-income households requiring support from costly programs like Medicaid.  Federal tax revenues also decline during any downturn, leaving less money to pay for these means-tested programs and for social insurance programs like Social Security and Medicare.

The firm’s second concern is that inequality is a drag on the economy. When the middle-class is squeezed, for example, they have less money to buy consumer goods. And when the economy slows down, inequality can increase, as it did in the years after the 2008-2009 recession.

This has played out in a widening wealth gap, Moody’s said.  The typical lower and middle-income worker’s net worth – assets minus liabilities – has shrunk since the recession, while net worth rose sharply for the people at the top.

One big reason for widening inequality is the stock market. Even though the market declined sharply this month, the post-recession bull market has beefed up investment portfolios – but only for the 50 percent of Americans who own company shares or stock mutual funds.

A second contribution to a widening wealth gap, post-recession, has been housing. A home is often the most valuable asset people own, so the steep drop in house prices and the spike in foreclosures were big setbacks for people who aspired to build wealth through homeownership. …Learn More

On the Web

October 4, 2018

If an alien were to drop in to study earthlings’ retirement, it would have to conclude that saving is either nearly hopeless or super easy.

Many Americans approach retirement planning with dread – hardly surprising, given that only about half of working-age adults are on track to have sufficient savings to retire in the lifestyle they’ve grown accustomed to while working.

But there purports to be an easier way – and it’s on YouTube. Googling “retirement” turns up all kinds of outlandish promises of nirvana for regular folks.  Examples of YouTube titles are: “Retire Young. Retire Rich.” “Guaranteed Ways to Retire Rich.” “How to Retire in 10 Years – Much Easier Than You Think.” You get the picture.

Don’t be fooled. In a 401(k) world, what workers need is determination, planning, and persistence to ensure they’ll be prepared for old age.  YouTube offers only magic bullets.

Many of these exploitative videos are targeted to 20-somethings new to the financial world, who may be more vulnerable and persuadable. But perhaps they are also able to attract hundreds or even thousands of viewers because they offer easy solutions to what may be our most anxiety-producing financial challenge: Will I ever be able to afford to retire?

Yes, one video claims. Retire at age 40! The self-appointed retirement expert in this video, who does not identify himself, hides behind cartoon illustrations on a white board to display his mathematical comparisons of workers who started saving at different ages. The point of this exercise is that people who start early will wind up with a better-funded retirement, due to compounding investment returns, than those who start in their 40s or 50s. So far so good.

But things quickly go downhill when he claims that it’s possible for a 23-year-old to retire in 17 years. You “don’t have to work another day in your life, and you’re still able to do the things you want to do,” he says, allowing this tantalizing prospect to sink in with the audience. But his retire-at-40 scheme has a catch – and it’s a big one. To achieve this goal, a 23-year-old would have to save half of his or her income. Young adults are trying to achieve independence – not move back in with their parents to follow his financial prescription. …Learn More