This may be quite a downer for some, but so be it. It has to be said.
You see, my mother is just a couple years away from retiring and has held out so far for full Social Security benefits, as anyone in good health should.
Of course, she is well aware that she cannot count on it for more than subsistence living now and that within a couple decades, it will provide far less. By 2023, the fund will be insolvent and pay 70% or less of current benefits.
In reality — even with prudent planning, a lifetime of saving, and a well-timed housing downsize just after the market started to implode — her funds are far from secure. From the looks of it, there won’t be much, if anything at all, left over for her family.
The short version is this: don’t count on the wealth you have today to be around within the next couple decades.
Here is the long version…
Gains Happen When You Sell
I first felt obliged to chime in when we discussed what she held in her retirement plans.
She has steadily contributed to a 401(k) for decades and has put excess savings in an IRA in recent years.
But as I pointed out, the information about her finances going forward was entirely based on current “paper values” of the investments. With the markets propped up to all-time highs, such an approach is extremely dangerous.
Invariably, anyone holding shares has not seen a gain until he or she sells. Within the next two decades, finding someone to sell shares to is going to be increasingly difficult.
In fact, it may be impossible for some of the later retirees.
The Pew Charitable Trusts did some research into this and found that married Americans born during the first part of the baby boom, from 1946 to 1955, can expect to retire with about 82% of their income.
The younger boomers, born between 1956 and 1964, can expect to quit work and make about 59% of pre-retirement earnings.
Meanwhile, the typical Gen X couple born between 1966 and 1975 only has enough savings to replace half of their pre-retirement earnings.
And then there is the youngest generation of people in the workforce, Gen Y or Millennials (pick your term). Born between the early 1980s and the late 1990s, this generation has an unemployment rate over 15%, and about 30% have to live with parents to make ends meet.
Tag on student loan debt, and it’ll be a solid decade of debt management using stagnant wages before retirement savings are a possibility for most of Gen Y.
There is plenty of time left for Gen X and Y to save, but you have to factor in how compound interest works…
According to the same Pew study cited above, the typical Gen Xers lost the most from the market crash, with 45% of pre-recession net worth of $75,077 vanishing from 2007 to 2010.
The Great Recession essentially erased 10 years of gains for Gen X, using average savings and wages, and is destroying the potential for Gen Y to crawl out of debt and save in their 20s and 30s.
Selling the Family House
Of course, most baby boomers have a one-time source of income that could dramatically improve their retirement funds. In fact, it normally accounts for virtually all of their net worth.
This worked for my mother quite well. She decided the sentimental reasons to stay in our family’s house after everyone else was gone were not practical. The house she bought in 1988 sold for twice as much nearly 30 years later.
The townhouse she purchased soaked up much of that, but it definitely added some padding to her savings overall.
Unfortunately, when you factor in debt and the need for a buyer, selling the family house and moving to an apartment or condo isn’t going to do a whole lot for most Americans.
Take a look at the chart to the right. For many Americans in the second to fourth wealth quintiles (20% to 80%), a vast majority of their assets are tied up in a principal residence.
Also note that the debt-to-income ratio is around 150%. Americans simply owe a whole lot compared to the assets they own.
Total home mortgage debt is now about five times larger than it was 20 years ago, and nearly 29% of all homes with a mortgage are underwater.
To put it succinctly, most baby boomers would simply turn around and repay their mortgage lender with little to nothing left over. The primary asset they own would simply change hands.
Betting on finding a buyer or on dramatically increased property values isn’t safe anymore, either.
Even with mortgage rates at historical lows, homeownership for Americans 35 and younger declined to 36.2% in Q1 2014 to hit the lowest percentage since the U.S. Census’ Housing Vacancy Survey began in 1982.
For Americans aged 45 to 54, the homeownership rate is over 70%. For those 55 to 64, it is above 76%, and for all Americans over 65, it is above 80%.
There is no chance of a large surge in home buying when 10% to 20% down payments are required, student debt makes creditworthiness questionable at best, and wage growth looks like this:
And sure enough, mortgage originations, with a one-year moving average to reduce volatility, just hit a 13-year low according to the Fed.
That trend leaves one realistic scenario: home prices will not see broad gains in the long term and cannot be counted on to fund retirement plans.
What To Do?
So stocks and equities are dangerous to continue to hold in the long term or to count on for retirement because of a trough in savings and investments through retirement plans. A seller’s market would drive down valuations and erase paper balances before the positions are sold.
Add in the Fed increasing rates next year, markets at all-time highs with anemic growth, and soaring corporate debt being used on buybacks instead of capital growth, and a correction is inevitable.
Meanwhile, the greatest source of wealth on paper for most Americans isn’t going to grow. In fact, housing values for many Americans that will retire in the next several decades will never return to their purchase prices.
Both types of assets hopelessly rely on “the greater fool” who will buy whatever you bought for more than you paid.
There isn’t much to do about housing, I’m afraid. Ditching the sentimental ties to a house and being disciplined will help. Even if you don’t plan on selling, track regional prices and inventory, and ignore headline news for the most part.
After all, housing is a purely regional market for everything from vacancies and prices to mortgage rates and demographics.
Thankfully, the options for the market are far more expansive.
First up, get your retirement plan in order. The market is at all-time highs, and 401(k)s are extremely inflexible. You don’t have to run for the hills right this second, but be prepared to when the time comes.
That means getting your contingency plans in place and your allocations correct.
The standard rule is 100 minus your age equals the percentage of your 401(k) that should be held in stocks. Consider going lower than that and plan on being flexible when you exit the work force.
Research shifting new savings to a low-fee IRA, where you can enter stop-losses and customize equity investments. Rollovers are possible, but be wary of the fees packaged with some of these options.
Utilize extremely low-cost ETFs, little known low-volatility strategies that crush 401(k) average returns over time, and invest in sectors that are irrationally undervalued.
Finally, you can make sure you hold a good hedge for rough times. Look at this chart from 2007 — when it was becoming obvious something was really wrong — through today:
The blue line is the S&P 500, and the yellow line is gold. With current gold prices at unsustainable levels for miners and the start of a new 40-year cycle, we can expect to see gold outpacing the market again.
