BC: BOOMER BEAR
Retire On Phantom Wealth? No Way
By Thornton Parker
Sunday, May 6, 2001
The panel named by President Bush last week to study Social Security is almost certain to recommend that workers be allowed to divert some of their Social Security contributions into stocks and private investment accounts. But there is a profound problem with that approach: the fundamental mismatch between what stocks do and what retirees need.
These days, few stocks pay significant dividends, so the only reason to buy them for retirement plans is appreciation -- that is, the expected increase in the price of shares. But until a stock is sold, any increase in its price is just a paper gain, and paper gains don't buy groceries. What retirees need is dependable cash income -- such as dividends once provided.
Baby boomers' retirement plans have created a national stocks-for-retirement cycle, in which workers buy shares that they will sell later for retirement income. Already, about half the value of all U.S. stocks is held in some kind of retirement portfolio -- pension plans, 401(k)s, IRAs and so on. Diverting some Social Security payroll taxes into stocks would increase that proportion. Because this concentration of stocks in retirement savings is unprecedented, nobody has any idea how it is going to play out. Yet, from Wall Street to Capitol Hill, nearly everybody who is talking about stocks and retirement investments is concentrating on the front -- or buying -- half of the cycle and ignoring the back -- or selling -- half.
And it's the selling that becomes problematic, because when stocks currently being held as retirement investments are sold, who will buy them? And as the market becomes flooded with such shares, at what price? Most stocks are purchased by people in their peak earning years, between the ages of 40 and 60. By 2030, about a third of American adults will be in that age group. Another third, roughly, will be at retirement age, from the early sixties on up. They will be selling their stock. The youngest third will be 20 to 40 years old, workers who traditionally don't buy much stock.
The problem with the current Social Security system is this: As the oldest third retires and begins to collect a monthly payment, there will be too few workers among the younger two-thirds to pay the payroll taxes to support it. Stock-based retirement plans have an even greater problem: They will depend for support on just that middle third, the traditional stock buyers, or roughly half as many supporters as Social Security will have.
As with any business that buys things to sell later, two factors will determine whether the stock-based retirement plans can be successful. They are the quantity of stocks that will be sold and the purchasing power that will be available to buy them. Nothing else will matter.
Some stock advocates look to foreign buyers to pick up the slack, but nobody has shown why they can be expected to do so. A 1998 report by the Organization for Economic Cooperation and Development said that most developed countries will have greater economic, social and political problems meeting the needs of their aging populations than the United States is likely to face.
It seems bizarre that the apparent danger to stock-based plans isn't being discussed. In 10 years, as waves of boomers start collecting their pensions, giant retirement plans such as those at General Motors and IBM, and large state plans such as those of California and New York, will have to begin selling increasing amounts of their stock holdings to pay those retirees. Meanwhile, retirees who look with satisfaction to the substantial paper gains that have accrued to their 401(k)s and IRAs will start selling shares to survive. With the owners of about half of the country's stock shifting from a buying into a slow selling mode, it won't be just a question of stocks not gaining value. The big worry will be: How much can they lose?
According to a recent Barron's article, by the beginning of April, an estimated $5 trillion that was based on stock prices had vanished in the preceding 12 months. That money was phantom wealth.
Phantom wealth is created or destroyed in two steps. The first step is a trade that sets the most recent price for a stock. The second step is the practice of treating all shares of that stock as being worth the most recent price. To understand this, assume that a company has 100 million shares of stock outstanding, and a day's trading leaves the price one dollar higher. When all 100 million shares, including those in retirement accounts, are treated as being worth the new price, $100 million appears to have been created, but nobody knows where all that money came from. If the share price goes down one dollar a day or two later, the $100 million vanishes -- it was only a phantom.
Few people have any conception of how rapidly phantom wealth can disappear as the result of a few trades at lower prices, but it is the primary asset in most pension plans and retirement accounts. There is a serious risk that the planned selling to pay for boomers' retirement consumption can depress stock prices for years, destroy trillions of dollars of phantom wealth.
The president's panel will probably be guided by popular wisdom such as, "Everybody knows that stock prices fluctuate, but over the years, stocks have been very good investments." Much of that universal knowledge comes from widely quoted reports that show how the total returns from stocks have done well for the past 75 years.
But a close look at the data behind those reports shows something much more important. For more than half a century, stocks returned more as dividends than as appreciation. Then, after 1981, retirement savings began to pour into the market and companies were driven to inflate their stocks instead of paying dividends. As a result, returns from appreciation were five times greater than from dividends. Many boomers believe that the bull market that began in 1982 was typical, but the gains of the past 19 years are unprecedented, because they have been driven largely by boomers' retirement plan purchases in the front half of the stocks-for-retirement cycle. If anything, those reports are a warning of what to expect in the back half.
Individual investment accounts, such as those proposed for Social Security funds, appeal to values that most Americans admire: self-sufficiency, simplicity and thrift. But someone who builds a nest egg of shares that will have to be sold must decide how long to stretch the sales. I call that the Impossible Decision, because it requires predicting how long one expects to live.
Actuaries routinely make life expectancy projections for large groups of people. But making that projection for just one person is like trying for a hole-in-one on the golf course -- it can be done, just don't count on it. Overestimating can lead to a lower standard of living than is necessary, while underestimating can lead to spending one's last years in poverty.
Having helped several older friends and family members manage their affairs, I know that security is often their primary concern. I also know that it is harder for many people to make smart, balanced decisions that involve many details at 80 than it was at 40. It is absurd to expect millions of older people to manage the sales of their stocks as market prices keep changing. Individually managed accounts will put additional pressure on them when they retire and can turn their later years into a nightmare.
Many older boomers will find that they should put their assets into pools, like annuities, that can be managed by experts who will make the decisions that they simply can't make for themselves. If those who have only modest savings (and are lucky) do this, they will wind up with something very much like Social Security.
Social Security's problems are well understood because each year it publishes long-term projections. There has never been a comparable projection for the stocks-for-retirement cycle. If Bush's panel is going to make a convincing case for using stocks to supplement Social Security, it must show, in an analysis that is comparable to the Social Security projections, how the cycle can work and who will buy all the stocks that must be sold at prices necessary to support aging baby boomers. The panel must also explain how boomers will handle the Impossible Decision.
The country must avoid rushing into even partial Social Security privatization without thinking it through. We did that with utility deregulation. What we don't need is a retirement brownout.Thornton Parker, who served in the executive office under every president from Lyndon Johnson to Ronald Reagan, is the author of the recently published "What If Boomers Can't Retire? How to Build Real Security, Not Phantom Wealth" (Berrett-Koehler).
© 2001 The Washington Post Company |
