Jesse Meijers

The generation of my grandparents have it made basically. They worked hard for 40 years and then they received a nice pension from their retirement plan that they had saved for over the course of those 40 years. How can this plan be flawed at all? Don’t all people simply save money to put into their retirement plan and justly receive this money when they retire?

You’ve probably guessed the answer: NO. But to understand why this is the case, it is very important to first understand how retirment works. The idea of course, is that a person saves money and at the end of their working life, receives this money in monthly pay. In practice however, this is far from true.

Retirement Funds

First one must understand that most people put the money they save for  their retirement in a retirement fund. What they don’t know however is that this fund invests their money. Otherwise, the retirement fund would not be able to pay interest over the money, which is one of the incentives for the retiree to put his money in such a fund. So there is no actual money stash somewhere. Now, these funds have money coming in before they have to pay the money, because people first save and then receive. In the meanwhile the retirement fund invests the money.

Let me stress that there is nothing wrong with this. Actually, it is the sole reason you receive interest when you place your money in a bank or fund. They invest, making some return and then give you back a percentage. But there is an assumption in this model which is very important. It assumes that money in is equal or greater than money out. And this has been the case for many years.

Ageing Population

In many countries around the world we are currently faced with an ageing population. This is of course due to the after-world-war-2 baby boom. These people are now around the age of retiring. But the population that is forming the working population of years to come, is much smaller. We will have a world with many elderly people, receiving pensions, and less working people, putting money into those retirement funds. More money will go out than is coming in.

Retirement Plans

There are different retirement plans. In the USA there is a distinction between DB (defined benefit) and DC (defined contribution) retirement plans for example. A DB plan basically states that a person puts amount X into his retirement fund per month while working and then receives amount Y per month after retirement at a certain age. A DC plan states that the employee is allowed to put any amount in they wish, and this will save up to some total. The total is then used to pay the person after they retire. These plans exist in many countries, by different names.

The big problem here is that the DB pension plans are what our parents and grandparents had. Most of the current working population have DC plans. But we still think we have DB plans! Many people are not putting any money into their DC pension plan. While the earlier you start, the better.

Investing

As stated before, the retirement funds invest your money for you. The sad news is, they are bad at it. That’s right, your pension is at stake because the people investing your money are not competent! Why? Well, most retirement funds invest in big mutual funds. In short they put all the money coming in onto 1 big pile and then buy many different stocks. Some go up, some down, but the risk is diversified.

The problem here is that this assumes that the stock market will, on average, always go up. This is actually most probably true. However, that is not the question you should ask. The question you should ask is whether you can sit out any down market. And the answer is; you probably can’t. There have been times when the market has been down for as much as 25 years. ’Safe’ diversified investments (many small stakes in the stock market), mimic the market trend; if the market goes up, you make money and if the market goes down you lose money.

The worst is still to come

Right now many people are losing retirement money. I have heard many people around me who have seen their retirement savings drop by as much as 50%. If you just started you have time to make up for the losses. But if you’re only a few years away from retirement … you are in trouble. You may not be able to retire at all. Such is the sad truth.

But things will become worse. Think about what will happen when all the baby boomers see their retirement go up in smoke. They still want to retire, and have a right to do so if you ask me. But our working population will then shrink. And that means that less people will need to provide for more retired people. Then there are two solutions: people are forced to retire at an older age or taxes go up for the younger people. Since there are more old people than young people by then, it is a safe bet that taxes will go up to cover the costs. Because those old people will vote for politicians who will raise taxes for the working population and leave the retirement age at whatever it is.

There are many more reasons why your retirement money isn’t safe and why the future brings big challenges. I can only suggest to look into your own retirement plan if you have any control over it. Put an effort in to thoroughly understand your own retirement plan, and beware of assumptions being made (like the stock market always going up).

I urge everyone to become truly financially literate. Before it is too late. As a start I can recommend the following books: Rich Dad, Poor Dad and Rich Dad’s Prophecy. The first is about the basics why rich people are rich and poor and middle class people are not and provides a great start to become more literate financially. The second is about ERISA (a law from the ’70s) and the ageing population in America. Many of the issues are universally applicable.

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