The current system is not working and we need a comprehensive approach that includes some form of mandatory savings in addition to Social Security.
Laurence D. Fink, chairman and CEO of BlackRock and an NYU Trustee, spoke with NYU Stern MBA students and faculty on "Longevity in the Age of Twitter," highlighting how the retirement landscape has changed significantly over the past 50 years, largely due to longevity, and the need for a national debate on how to rework the current retirement system. Following the talk, Mr. Fink answered questions from the audience.
"The current system is not working and we need a comprehensive approach that includes some form of mandatory savings in addition to Social Security," said Fink. "As tomorrow’s leaders, I’d like to ask you two things. The first is simple: if you’re not saving for your retirement already, start today… Second, I hope that all of you speak out. Longevity is an issue of social justice that will have a more profound impact on your generation than any generation before
Here in the U.S., a recent paper by two noted economists argues that an aging workforce is one reason the current recovery has been so slow and that jobless recoveries will now be the norm. I’m not quite that gloomy. I think that a college education can be an enormous help, especially if we can direct people to growth areas like technology, health care, energy and engineering. The unemployment rate for college grads is actually under four percent. But the simple fact is that as older people work longer, young people are being displaced – total employment among those without a college education is actually continuing to fall.
So the Grey Society – with all its challenges – is global. It is real and it is now. It’s already burdening governments, depressing economies and suppressing job opportunities. And no one has done enough to get ready.
Governments aren’t ready. The president’s budget plan projects that Social Security and Medicare outlays will both rise more than 70 percent by 2023 – it’s unsustainable. State and local government pensions are underfunded by nearly a trillion dollars.
Companies aren’t ready. The top 100 corporate pension plans are nearly half a trillion dollars underfunded.
And individuals aren’t ready. According to the Employee Benefits Research Institute, only two thirds of workers have saved anything for retirement, and most workers have saved less than $25,000.
So we’re not ready for the Grey Society – government, business or individual investors. And the question is why?
The answer is that we have let all three legs of the traditional retirement “stool” – Social Security, pensions and personal savings – get rickety.
Retirees now depend on Social Security for 70 percent of their income. Social Security is an essential part of our retirement system, but Social Security was never intended to do the job alone – and it’s a system that was established for different demographics.
When Social Security was launched in 1935, a 21-year-old male had about a 50-50 chance of living to 65 and collecting benefits. In 1960, five workers were paying into the system for every retiree. Now, it’s three workers. In 2035, it will be just two.
And while the solutions may seem obvious – adjusting benefits and raising the retirement age – these are difficult and emotional issues. In many states, state and local governments have similar obligations and are working to address them. But as a society, we keep kicking the can down the road.
The second leg of the traditional retirement stool was so-called defined benefit pensions. These are the traditional pension plans that provide a set income during retirement. They are managed by employers and mostly or completely funded by them. But over the past thirty years, we’ve had a massive shift away from defined benefit pension plans in the private sector. Employers found they simply couldn’t afford to support the liabilities created as Baby Boomers aged and their liabilities rose.
Companies responded by freezing pension plans and shifting the retirement risk and burden to individual employees through so-called defined contribution plans such as 401(k)s, where workers save for their own retirement.
This is a seismic shift from collective responsibility for retirement to individual responsibility. But we never sufficiently warned people about this new responsibility – and we never educated them about how to meet it. As a result, the defined contribution system simply isn’t doing the job.
As of 2011, only about half of private-sector workers were covered by an employer-sponsored retirement plan of any kind – and less than 40 percent participated. That means the majority of private sector workers aren’t participating in this vital part of our nation’s retirement system. And even where employers offer plans, less than seven percent of eligible employees maxed out their 401(k)s in 2010 despite the benefits to doing so.
Which brings us to the third leg of our retirement system, private savings, where too many investors are simply not equipped for success. In a recent BlackRock survey, more than half of investors were worried about outliving their savings, but at the same time nearly three of four said it was more important to keep the money that they have now safe, than to try to generate the returns they’ll need for the future.
When individuals manage their own retirement savings – whether in 401(k)s or taxable accounts – we see that they invest much more in traditional fixed income than pension fund managers do. But in today’s environment, that isn’t going to deliver the returns they need.
So why aren’t people taking the steps needed to plan for their retirement? Part of the answer is investor psychology. As behavioral economist Daniel Kahneman has found, people’s investment behavior is not as rational as most economic theories assume.
Investors feel more pain when they lose money than pleasure when they gain. So they often underinvest or do nothing at all when left to their own devices. We’re not going to change human behavior, but we need to find ways to influence it.
Investors also don’t take a long-term view. They are too concerned about all the noise out there, all the ups and downs in the markets. After all, just last month, a hoax tweet from a hacker sent the Dow plunging 145 points in an instant. And we live in a world of 9,000 tweets a second.
The entire system is now wired toward the short term. Banks and securities firms grow revenue from the velocity of money. So they have a short-term incentive. Media, especially in the online age of the 24/7 news cycle, draw traffic from hyper-focusing on the latest development. That noise – and the concern people have about outliving their savings – are ironically driving investors to investments they perceive to be safer, like traditional bonds.
But they should do just the opposite, taking advantage of their longer investment horizon to keep their money working for them. Because let’s face it – if you have 25, 30 or 40 years to save for retirement and 20 or 30 years to fund in retirement, you should not be worrying about what’s happening this second, today, this week – even this quarter.
That’s all the more the case given today’s economic landscape. Central banks in the U.S., in Europe and now in Japan have driven interest rates to historic lows to help spur growth, with some positive effect on housing, bank lending, energy and corporate investment.
Yet current monetary policy is taking a terrible toll on savers. Pension plans and individuals have long used traditional government bonds to help fund retirement obligations. That worked for 30 years of falling inflation and interest rates and eight percent returns on Treasuries.
But it doesn’t work today when the 10-year Treasury yields less than two percent. And the very real risk is that people over-allocating to traditional bond funds are going to lose money when interest rates rise and the value of their bonds falls, which must happen at one point. This will deprive investors of flexibility and force them to hold to maturity to recover their principal.
A rise of just one fifth of one percentage point in interest rates would mean the loss of an entire year’s return on current long-dated Treasuries. In other words, the old rules of investing – 60 percent equities, 40 percent fixed income and an increasing share of fixed income the closer you got to retirement – won’t work today. Investors need to take a different approach that can deliver the higher rate of return they’ll need to support their longer lives – investing in a wider range of stocks and bonds.
Bonds have an important part to play in an investment portfolio, especially as people age. But people can’t just rely on Treasuries for their bond portfolio. They need to look at a broader array of bonds that can deliver higher yields. And for younger workers, they need an objective-based approach that focuses on what they’re trying to achieve and how they can get there.
That’s especially true when you consider the powerful effects of compounding. If you saved $1,000 a month for 30 years with a 3% annual return – close to the 30-year bond yield today – you’d have less than $600,000 when you reached retirement. But if you invested that $1,000 in something that delivered 6% a year – a reasonable return in many equities – you’d end up with $1 million over the same period of time. You’d need to save more than $1,700 a month to get to the same million dollar outcome over 30 years at 3%.
By now, I think we all get the problem. So the question is what do we do about it? Well, first we need to acknowledge there is a crisis, a systemic crisis that is threatening not only retirement systems but also our economic futures. And because of its far-reaching effects, a solution needs to be as big and urgent a national priority as anything we have faced in recent years. The longer we wait to act, the bigger the problem will become.
Once we’ve faced up to the crisis of how to finance longer lives, we need action on several fronts. First, employers need to step up – in every way that can help workers achieve a secure retirement. Shifting from defined benefit plans to defined contribution plans does not absolve employers from the moral obligation to help employees prepare for retirement. More employers need to offer plans, auto-enroll all employees, provide matching funds and educate employees on the absolute necessity of maxing out their plans. The bottom line is employers need to do more to fund their workers’ retirement.
Second, the asset management industry – including my company, BlackRock – needs to do a better job as well. As an industry, we need to measure our performance not against benchmarks but against investors’ objectives or liabilities. That means much less of a focus on short-term sales and products – and more on investors’ long-term needs. Investors don’t care if a fund holds mid-cap stocks or Mexican government debt. Investors want products that will provide long-term outcomes to help buy a house, send a kid to college or fund a decent retirement.
We cannot provide absolute certainty – that’s never an option with any investment that carries a measure of risk. But we must do a much better job of accompanying savers on their life journeys with outcome-oriented solutions that help them understand how to stay on course – with target date funds, target risk funds and multi-asset solutions made for today’s world and tomorrow’s goals.
And we need to help investors look beyond the headlines – recognizing that successful investing is not about timing the market – but about time in the market. It’s why, at BlackRock, we’ve embarked on an education campaign to get investors focused on broader opportunities in the market and the need for a long-term, patient approach.
But in the end, we need to go even further. Given the massive amounts of savings needed – as well as investor psychology and the reality of risk aversion – we need a comprehensive solution to retirement savings that includes some form of mandatory retirement savings, similar to Australia’s successful superannuation system or the new pension requirements in the UK.
For example, in Australia, for every part-time and full-time employee age 18 to 70, employers must contribute a portion of income into a superannuation account, which then belongs to the employee. It was launched twenty years ago, when the country looked ahead to the crisis it would face in paying for retirements. At the start, the contribution was just 3% of income. It’s gradually risen to 9% of income today and will rise to 12% by 2020. And individuals can make additional contributions on top of that.
Superannuation has been a huge success in supplementing the government pension scheme and taking the strain off it – an attractive prospect as we think about how to relieve the burden on Social Security in this country. All told, in just twenty years, more than $1.6 trillion in assets are held in these accounts – giving Australians one of the highest per capita retirement savings pools in the world.