On Irrational Retirement Strategies

“Most people are systematically irrational when it comes to retirement planning. They overlook the magic of compound interest and dollar cost averaging, waiting for their first gray hairs to start seriously saving for retirement. And so the government needs to make people start saving, starting young…”

That’s the story we hear from the smaller government conservatives. The liberals go further, assuming that the peons are too stupid to make any retirement choices, so we need Social Security – as if Congress was a better portfolio manager.

Is this story right? Are people irrational? It is certainly true that many people wait too long to start saving for retirement; that is, if they are going to use stocks as their main investment vehicle. I am rather guilty myself, and many of my libertarian friends are much worse. It does appear that if we want to replace Social Security with private retirement accounts as generally conceived, then we need to either force them Chilean style, or deal with destitute old people.

As I contemplate this dilemma, another asserts itself: stocks are a safe retirement option only for those who invest over decades. Over shorter spans the volatility is unacceptable save for those who like to gamble. Even if stock market investing is the ideal long term retirement option, how do we make the transition from Social Security to private accounts for those over 40? How about those over 30 even? The liberals have a point when they scream about Wall St. ripping off retirees and undue risk, especially for those trying to catch up late in their careers.

Then again, maybe typical human investment behavior isn’t irrational under a more free market system! When you are young, should you invest in your education or stocks? Later, should you put your savings in a retirement account or in your own business? And how about your house: if it weren’t for the tax deductibility of mortgage interest, paying off your mortgage early is a very conservative and predictable investment. And what about rearing children: should both parents work in order to have money to put away for retirement, or is it better for one to stay home to raise the children? Now consider the years after the children have grown and finished college: these are excellent years for both parents to work and maybe save a large fraction of their combined income.

This conservative, non-Wall St. retirement strategy could work, if we got rid of laws which encourage financial recklessness. Get rid of the mortgage deduction and paying down the mortgage makes sense. Allow unused IRA deductions to carry over to later years. Outlaw aggressive maturity transformation on the part of banks and go to a gold standard, and plain old bank certificates of deposit could provide a decent predictable return on investment for both existing retirees and for people who opt to go on a savings spree during the height of their careers.

Maybe default human behavior is rational after all, in an environment of rational economic policy. It thus follows that we need the rational economic policy before we eliminate Social Security. Order of operations is important.

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stocks move in great waves.

stocks move in great waves. Profitable over decades,negative over other decades. Investors in 1929 will wait decades to break even. Stocks are no panacea. There is no established retirement vehicle. No safe place to place the great wealth of society for safe keeping. There is just no assurance of growth. Especially when you open it up to the masses.

How do the masses save for retirement without losing their shirts?


As I said, for a catch-up cram, stocks are a poor option. If we had high reserve requirements, then the yield curve would steepen and ordinary bank CDs would have real ROI.

But with regard to 1929, keep in mind that during the 1930s dividend rates were high, higher than bond rates. Any analysis of stock returns which neglects dividends over this period would be overly pessimistic.

Remember also that a stock based retirement plan would automatically dollar cost average if you bought index fund shares with each contribution. If you worked from 1925-1960, you would have bought some inflated shares in 1929 but also some deflated shares soon thereafter.Your average cost basis would in between.

If you have the personality for it . . .

there is always slumlording. I don't have the personality for it.