My dear, your being down is in the nature of things

“I don’t want downs!” shrieked Lucy.  “I want only ups!  I want to go from an up to an upper up!”

So it is with investors and risk; we’re delighted to take the ups – we even congratulate ourselves on our sagacity and daring – but we become apoplectic at the downs.

Does the word begin with F?

So, it seems, are the editors of the New York Times, who have authored a nothing-but-upper-ups editorial

If you have a 401(k) retirement plan at work, you don’t need us to tell you that you’ve taken a hit in the past year. The really bad news is that the damage to your retirement security is likely worse than what the numbers say on your statement.

Many Americans didn’t have enough savings coming into the downturn.

Okay, stipulating that to be true arguendo, whose fault is it that they don’t?

And employers are increasingly cutting back or suspending their 401(k) match.  FedEx, Eastman Kodak, Motorola, General Motors and Ford, among others, have announced such moves.

There’s also no guarantee that today’s battered 401(k)’s will rebound powerfully.

There’s no guarantee of anything.

People close to retirement don’t have time for a do-over.

Lest those reading the editorial not be themselves close to retirement, the Times wants you to feel afraid too:

I fear the wrath of Times

Even for those still far from retirement, there’s no telling how stocks will perform in the future.

That’s always been the case.  You could have invested your 401(k) in bonds or treasuries.  Or you could have a defined-benefit plan (which was the old model) – but then you face the risk, as my grandfather had it, that your company will go bust before you retire.  He worked for over two decades at the Saturday Evening Post, and built up a very nice pension.  Unfortunately, the Post went under, and with it his pension.  From that financial implosion and several others we enacted legislation – ERISA, the Employee Retirement Income Security Act –to safeguard pension money from plunder or corporate collapse, and then enacted 401(k) because it was a better investment alternative for individuals. 

Here’s Wikipedia’s summary of the history:

In 1978, Congress amended the Internal Revenue Code by adding section 401(k), whereby employees are not taxed on income they choose to receive as deferred compensation rather than direct compensation.  By 1984 there were 17,303 companies offering 401(k) plans.  In 1998, Congress passed legislation that allowed employers to have all employees contribute a certain amount into a 401(k) plan unless the employee expressly elects not to contribute.  By 2003, there were 438,000 companies with 401(k) plans.

Originally intended for executives, the section 401(k) plan proved popular with workers at all levels because it:

Had higher yearly contribution limits than the IRA

Usually came with a company match

Provided greater flexibility than the IRA, often providing loans

If applicable, offered the employer’s stock as an investment choice.

It is, in short, a better mousetrap.

Is that my retirement cheese?

The danger of the 401(k) plan is if the contributions are not diversified, particularly if the company had strongly encouraged its workers to invest their plans in their employer itself. Congress inserted trust law fiduciary liability upon employers who did not prudently diversify plan assets.

Today 401(k)’s are the retirement savings vehicle of choice, because they incentivize savings, are easy to administer, give employers a reliable expenditure stream, and give recipients wide choice in their investment strategy. 

Most people, quite rationally, put their 401(k)’s into equities.  Which go down, as the Times bemoans, but also up:

I want only upper ups!

They could post impressive gains, especially in the near term, from their current low levels. But they could also struggle. The last 25 years was a time of low inflation rates and low interest rates, which boosted stock prices. Going forward, inflation and interest rates have nowhere to go but up, which would be bad for stocks.

This is populist nonsense.  In general, inflation is the young’s revenge on the old for their over-spending.  As the world’s foremost consulting housing financial theorists, Sherlock Holmes, put it:

“If revenge is a dish best served cold,” said Holmes, “then inflation is a dish long marinated.  Inflation is the young’s revenge on their elders for over-spending.  In fact” – he twirled his fingers and the image appeared – “we may express it as a law.”

“Fortunately or otherwise,” Holmes said with a thin smile, “once money was invented, inflation came along with it.  As opposed to pure barter, where commodities and services are exchanged directly – money is always an abstract representation of a unit of value.”

Meaning that the value of money is what you can buy with it.  So inflation, if it comes back – which it will, with a vengeance – devalues debt instruments, increases the value of commodities and equities.  Stock will come back when inflation does – probably before.

It wasn’t supposed to be this way. Over the last several decades, businesses and government used matching contributions and tax breaks to encourage the proliferation of 401(k)’s. They lauded them as a way to harness the market to create wealth and increasingly viewed them as replacements for traditional corporate pensions.

Well, they were.  Indeed, they encouraged people to save, tax-free.  Remembe the Times bewailing that Americans didn’t save enough?  It wasn’t for lack of incentives or vehicles.  Nothing could have been easier that to put away more of one’s paycheck.

My company uses 401(k)’s.  We believe in them; we fund a match. 

In 1983, 62% of workers with retirement coverage had a traditional pension only, while a mere 12% had 401(k)’s. Today, approximately 20% have a traditional pension and about two-thirds have only 401(k)’s.

Because they’re better.  Because defined-benefit is a different fool’s game.  Because there ain’t no such thing as a free risk premium. 

The shift to 401(k)’s also shifted investing risks and responsibilities from employers to employees, but as long as participants generally made money and recovered losses quickly, the risks seemed reasonable.

Seemed?  I know not seemed.  The risks were reasonable.  Investing in a 401(k) didn’t compel you to put your money into equities.  Most companies offered a range of funds, from heavily debt-oriented to mostly equities.  So each investor could decide where he or she wanted to be on the risk curve.\

Don’t say you didn’t have choices

Choices within choices

Now many Americans are inevitably having second thoughts.

Would it be too cynical to say they are now having first thoughts?

Perhaps you should have thought through your actions first?

So far, the cumulative wipe-out of household retirement savings totals about $2 trillion, and no one believes that the downturn is anywhere near over. As a result, participants in 401(k)’s are in greater danger than ever of coming up short in retirement.

Yes, let no one doubt that the global de-leveraging will hit everybody – that’s the definition of a financial pandemic – among them the soon-to-be-retirees of my boomer generation, who always spent as if there would be no tomorrow.

That grim reality calls for an expanded approach by policy makers to retirement issues.

I’m from the Department of Post-Mortem Investments and I’m here to expand my approach

Well, does it? 

Traditionally — and correctly — an important focus has been on lower-income Americans who lack the means to save and tend to work for employers who do not offer retirement plans.

Yes, and one could argue that they are the only part of the spectrum with whom government should concern itself.  Caveat emptor applies to all of us.

During the campaign, President Obama supported a better savers’ tax credit to encourage savings among lower-income Americans.

Fine, although this has nothing to do with the Times’ editorial thesis, that we need to reform how savings are invested and what options people should be allowed in investing their retirement savings.

He also supported universal IRA’s, which would make a 401(k)-like account available to all workers. Those good ideas should be pursued.

Can you hear the approaching but … ?

There are also good ideas for improving 401(k)’s that deserve attention, such as helping people manage their retirement withdrawals so that the money lasts a lifetime.

More should be made of this throwaway comment. 

Money, though conceptually simple, is in its deployment and management fiendishly complex.  Financial literacy doesn’t mean merely understanding how a mortgage loan works or how to balance your checkbook (at least in theory, or via input into Quicken or the like).  We’ve seen that savings precedes borrowing, that buying a home requires consulting help and asks you whom do you trust, and creates opportunities for complex fraud.

“A woman’s handshake is not legally binding.”

Doesn’t the reverse hold as well? 

If the home is people’s largest financial asset, aren’t their retirement savings the second largest?  When vastly wealthy people gave Bernie Madoff their investment money, relying on otherguy due diligence, we clucked at their naivete.  When my grandfather’s savings were wiped out, we patched the funding hole with ERISA.  In turn, he pulled up his socks and got a job at Newsweek, worked a few years longer than he had planned, and go through. 

The wipeout in 401(k)’s has made it clear that it is not enough to get more people to save more. There needs to be a better way to reasonably ensure that a lifetime of savings can’t be undone by forces beyond one’s control.

Like Lucy Van Pelt, the Times wants no downs, only ups and upper ups.

I can’t help those who deny reality

The Center for Retirement Research at Boston College, a leader in retirement policy, is advocating a new savings account — in addition to Social Security and 401(k)’s — that would enable risks to be shared among workers, retirees and the government.

Whoa!

You mean I can share my downs but not my ups?

[The proposal does not leap to the eyes from a quick peek at the CRR’s web site; any reader who can find the reference is invited to email me. – Ed.]

To insulate retirees from the consequences of their overspending, the Times would like to parcel out their risks to:

1. Current workers, who are already paying for employees’ retirement through their Social Security payments.  I don’t know anybody under the age of forty who sees Social Security as anything other than a contemporaneous transfer of taxes from themselves to their parents’ and grandparents’ generation.

2. The government, which is just us in another guise.

Got it?  The pain will be shared among retirees, current workers, and current workers.  Two out of three of these are innocent. 

Two of the three of us are apoplectic

To insulate people of my generation who overspent, they would tax those who didn’t – the young, who will already bear the burden as we dig our way out of this little mess – either directly (probably by taking a payroll deduction at source and funneling into retirees’ accountants – that’ll be popular), or indirectly (by taxing all of us).

“Don’t tax you and don’t tax me, tax that man behind the tree.”

– Senator Russell Long

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Down payment?  What’s that, dude?

Ant-like savings seems so vapidly incremental, one modest contribution at a time. 

Try not to judge too harshly the young people whose former insipidity is so on display in this article from New York Times:

Amy Wegenaar, 31, wanted her own place. But she found it hard to save because the rent on her Lower East Side apartment had crept up to $1,550 a month.

Much more fun to enjoy oneself in the moment:

Ms. Wegenaar is an art director for the Publicis Groupe and her main client is Garnier beauty products. She worried that on her annual salary of about $85,000, she couldn’t buy anything for more than $250,000.

A single person earning $85,000?  How ever could she make ends meet?

She also wanted an apartment large enough to fit her lunchbox collection, her Spiderman collection and her collection of Jack Skellington dolls in coffins from “The Nightmare Before Christmas.”

Sorry, there I go, judging harshly. 

I’m your worst nightmare

Let’s consider a more responsible couple:

WHEN Janey Lee and Pablo Aguero were struggling freelance Web designers, buying an apartment in Manhattan seemed like a dream, one clouded by credit-card debt, student loans that had to be repaid and the bills for their wedding.

Their choice of career also had something to do with it; things cost money, so earnings are the prerequisite.

But now, five years later, they are about to move into a $445,000 two-bedroom condo in Hamilton Heights, in Upper Manhattan, with their 5-month-old daughter, Matilda.

Children too are a motivator to become financially adult; while apartments may be associated with sex, children are associated with owned homes.

Their combined salaries of just over $100,000 qualified them for a mortgage, but it took a lot more for them to come up with the down payment.

In a city synonymous with luxury and spending, Ms. Lee, 30, and Mr. Aguero, 35, decided to do without.

Saving is not just about accumulation, it’s also about re-sizing consumption.

They gave up smoking to cut costs, they stopped meeting friends after work for beers, they didn’t buy new clothes, and they stashed away tax refunds and as much of their earnings as possible. Whenever they wanted to buy drinks, gadgets or cookware, they asked each other: “Do I want an iPod or a house? Do I want a latte or a house?”

Pick one

Given time, and disciplined habits, savings add up:

More impressive, perhaps, than their willpower was that they were able to save $90,000.

Often the will to save arises only after a loss:

Mr. Aguero and Ms. Lee say that losing their jobs in the dot-com collapse of 2001 gave them the motivation to save. Ms. Lee quickly found a new job but then was laid off again. Mr. Aguero said he spent a full year freelancing and living on $1,000 a month.

A lot of time advertising, less time being paid

Nothing imposes savings discipline like poverty:

He survived each day on a $2.95 chicken special from a local restaurant; a 99-cent Coke; and a pack of cigarettes, before he finally just gave them up.

They both wanted a safety net.

“That was the initial thing that motivated us,” Ms. Lee said. “There is no job security.”

After they opened their own Web design business, they tried not to return to their old spending habits. The couple found that they spent the most money when going out in a group for drinks. So they would suggest meeting their friends for brunch or heading to Chinatown, where they could buy meals for less than $15 each. They also found that they could save by cooking at home for their friends even when their Fresh Direct deliveries cost $100 a week.

Not to be too grimly Dickensian about such matters, but there is such a thing as a grocery store, to which one can walk, and home from which one can bring groceries.

This obtrusive lad insists on Fresh Direct deliveries

They slowly built up a nest egg. In 2002, they saved their $3,000 tax return [sic: refund] and another $5,000 between them. They said that it was hardest not to spend in the beginning: in one case they missed shopping so much that Mr. Aguero splurged on a pair of $300 Prada shoes.

The devil made me buy these shoes

The path to financial adulthood is slippery:

Must’ve been the Prada shoes

After wearing them a few times, he realized they didn’t really fit, so he sent them to his brother in Spain.

The Careful Shopper would have kept the sales slip, and returned them.

Those shoes became a symbol of the perils of impulse shopping. Over the next two years, they each saved $15,000.

By 2005, they thought about using their accumulated $38,000 in savings for a down payment. When they realized that they couldn’t afford anything, Mr. Aguero got a job at a bank and saved his entire annual take-home income of about $40,000.  

Homeownership is predicated on income stability, so there is a huge premium to shift from freelancing into regular income. 

They lived off Ms. Lee’s salary. That drove their savings up to $78,000.

Conversely, once one has established homeownership, the home incubates new business formation, both because it offers space in which to conceive and inaugurate a business, and also because there is appreciated equity.  Ownership of a home that is a financial asset therefore correlates powerfully with new business formation — and likewise, with economic growth.

By 2006, they had saved another $20,000, which pushed their savings up to $98,000. They started to search in their neighborhood, Washington Heights. They found the apartment in Hamilton Heights in November and put down $90,000. They hope to move in by the end of the year.

They are happy to be the first people they know to have reached their goal of buying an apartment. “We actually don’t have friends who own,” Ms. Lee said.  “We’re really kind of taking that leap, which is different from everybody else that we know.”

That difference depressed Ms. Wegenaar, of the Jack Skellington coffin dolls:

It’s enough to make a body die

She felt discouraged as her married friends bought apartments for more than double what she could afford, and as a single friend bought with help from her parents.

True enough, right up there with marrying right is being born to the right parents.

No homebuying problems for me!

In 2004, she started to save $400 a month from her paychecks, adding to that amount with raises and bonuses.  By late 2005, she had saved nearly $10,000 and found a $160,000 apartment in Ditmas Park, Brooklyn.  

Manhattan it ain’t

In the journey to savings and ownership, adjusting expectations is a key moment:

She had discovered Ditmas Park by searching listings in her price range on Craigslist.  When she visited the area with her parents, she found out that her father had grown up nearby, and that made the area more appealing.  But she still didn’t have enough money.

So she went into savings overdrive: she went grocery shopping only with a list and cut out luxuries like expensive juices.  When she went out with friends, she ordered the happy-hour drink specials and often chose Mexican food so they could munch on free chips and split a cheap entree.  She shopped the sales racks at Urban Outfitters and sewed dresses from discounted fabric she bought on the Lower East Side.

By October 2006, she had saved $17,000. When she found a $220,000 one-bedroom co-op in Ditmas Park that required only a 10% deposit, she wrote a $6,500 credit-card check to cover the shortfall for the down payment and closing costs.

Unfortunately for Ms. Wegenaar, she may well have unwittingly committed fraud.  Not by writing the check, but by falsely signing a representation that none of her down payment was borrowed.  And credit card debt is one that most lenders categorically reject as a legitimate down payment source.

“I can’t let $6,000 stand in the way between me and a home,” she said.

Don’t stand between me and a home

Fortunately for Ms. Wegenaar, no one noticed.

Her mother, sister and married friends who owned their apartments encouraged her to take the leap. Makeba Lloyd, a broker at the Developers Group in Brooklyn, sold her on the deal. Ms. Lloyd had moved into the same building in Ditmas Park several months before and talked about how happy she had been moving from Manhattan.

“She actually showed me her apartment, and she showed me what you could do with it,” Ms. Wegenaar said. “It felt so right.”

Similar thoughts are echoed by Mr. Aguero:

Mr. Aguero described it as “a mind-set,” adding, “If you want to own a place, you have to do everything to own a place and everything else comes second.”

Have I got enough for the down payment?

When I was a child, I spent as a child, I planned as a child, I bought as a child:

but when I became a man, I stopped buying childish things.

– 1 Corinthians 13:11

Now I see the value of owning a home

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