Eat Your Spinach
Chapter 1: The Case for Controlled Frugality
In the United States, and probably in most cities over the world, one
routinely sees young people decked out with a cell phone, an iPOD,
100 dollar jeans, and 200 dollar shoes, while they shop vigorously for more clothes, toys and exotic food and drink. Often they enjoy their own bedroom and bathroom in a large house, are driven to the mall in a shiny SUV, watch TV on huge screens and surf the Internet on their spiffy PC. In one way this is marvelous. Never have the young, even the offspring of the affluent in rich countries, had so much disposable cash and ready comfort. Self-expression, fun and the ability to attract friends are especially important to young people, and the consumer society is especially good at giving the youth market what it wants. We think it is a good idea to have fun while young, and as far as we can remember we did our best to do so in that far off time when we were in that retrospectively delightful state. We think it is commendable that the advanced economies of the "developed" world can produce the money and the avalanche of goods that make this state of affairs possible. We think it is great that young people are taking advantage of it and having a good time. We are not related to the Grinch, really.
A World of Potential Hurt
But we are worried. We think it may be that today’s youth think that they will find themselves in their parents’ and grandparents’ environment when they reach their age. And many parents continue to spend as if there is no tomorrow. We, the authors, don’t remember thinking anything at all about old age until we were well into our third decade, unless it was to feel fleeting pity for duffers over 30. But we were part of the “Lucky Generation”. Not only did our draft ages fall between Korea and Viet Nam, many of us didn’t have to worry much about later because of the pension and Social Security policies then in place and virtually forced on us. In fact, the world is changing rapidly around today’s youth, and in many ways it is changing so that things will be much harder when they reach “retirement age” or when a recession/depression finds them in a low-paying job or none at all. Even those in or near middle age may fall into the trap of seeing things as they were, not as they will become.
Increasingly, unless people begin to save and invest as early in life as possible, they risk facing an especially bleak later life. In the United States, the social safety net is eroding. “Defined benefit” pension plans (those which promise a given, often generous, guaranteed amount on retirement) are disappearing rapidly. In the best instance, they are being replaced with “defined contribution” plans (those which promise only income from the money contributed by and for the individual over their working lifetime, but not a definite amount). Most often for new ventures and “restructured” companies, pensions are being replaced with various government-blessed savings vehicles, such as the 401(k). These promise long term tax benefits, but are sharply limited in the amount of money that can be contributed to them annually. An Associated Press article by Brian Bergstein suggests that IBM’s retreat from its fiscally healthy defined benefit plan will be a wake-up call because it both illustrates the demise of traditional pensions and focuses on the 401K as an alternative. This has experts worried as to whether the 401K will be adequate to provide for retirement in its current form, and, as we explain below, we are sure it will not be adequate for most (The Oregonian, January 7, 2006).
Social Security, the perennial “third rail” of American politics, has apparently lost its politically lethal charge and schemes to change (many would say weaken or eliminate) it are proliferating. To take undue comfort from the fact that the Bush administration has backed away from its proposed changes is to underestimate the tenacity of politicians, and to ignore the dire straights into which the federal budget is plunging and the demographics of the future.
Health care costs are rising more rapidly than general inflation and the endless supply of new miracle drugs and treatments are ever more expensive. Partly because of these drugs and treatments, people are living longer and requiring ever more of them. This longer life often includes long periods of expensive nursing care that were rare only 20 years ago.
In the workplace, the lifetime job has become the exception rather than the rule; self-employment is on the rise. On the whole, we think this is a good thing. Self-reliance and risk taking are exhilarating. They lead to thought, effort, commitment and achievement. But they also provide a less sure, if often ultimately larger, income stream than the “steady job” of yesteryear. This means that individuals will need to provide, through savings and investment, for periods of low or no current income.
Finally, as China and India transform into world-class economies, there is no reason to believe that the United States and other “G8” countries will maintain their income edge. It may be that the rising tide of democracy and market capitalism will truly lift all boats. In fact, this is highly likely. But it is also likely that there will be a redistribution of wealth along with trade and productivity so that the relative affluence of the citizens of the G8 countries appears, and is, less. Therefore, just as poverty is often recognized in the comparison with others and not as an absolute, the amount of money one needs to feel included in the “good life” may greatly increase over the life of those now in their teens, twenties and thirties. So far we have systematically underestimated the rate of growth and change in the BRIC countries (Brazil, Russia, India and China). Together they contain well over half of the world’s population and resources. To expect them permanently to be denied our standard of living is simple-minded.
All the above reckon without calamity. World-wide depression, Carter-scale inflation, pestilence, bad weather, earthquakes, volcanoes and war often have ruined the prospects of millions. Except for the first two, wealth is not a certain shield from their effects. But, sometimes it is. Fair or not, people with money tended to get out of Nazi Germany easier than poor people. The affluent die at lower rates than the poor in most epidemics of most diseases. It is easier to rebuild your house and life after a hurricane if you have some money. So, a prudent person is financially responsible because there are some events that are relatively predictable (old age, illness, retirement) and because some are not. We are also capable of precipitating calamity ourselves, for example, through government policies. Paul Volcker, former chairman of the Federal Reserve Board, said in late 2005: “I don’t know of any country that has managed to consume and invest 6 percent more than it produces for long. I don’t know whether change will come with a bang or a whimper, whether sooner or later. But, as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change.”
For a reasonably apocalyptic but well-reasoned and immensely detailed view of the financial future of those who are now young Americans, you should read, without delay, “The Coming Generational Storm: What You Need to Know About America’s Economic Future” by Lawrence J. Kotlikoff and Scott Burns. If you accept their detailed analysis and logic, there is not a moment to lose to begin to prepare for your far financial future.
You Will Need a Large Pile of Money
Here is a brief example to illustrate the need for people from
twenty through forty to save and invest now. Suppose that after you include
your Social Security and pension income (if you're fortunate enough to
get a pension) you need an additional 20,000 dollars for the first year
of your retirement. This 20,000 dollars will come out of your own retirement
savings. And further assume that each year after that your expenses increase
because of inflation. So the 20,000 dollars requirement gets larger every
year. Also assume you will live for 30 years after you retire at 65. Finally,
if you assume an average inflation rate of 4 percent and an average rate
of return of 6 percent on your investment during retirement, you will
need 436,000 dollars at the start of your retirement. Given that all the
assumptions hold you will have enough money to last 30 years.
Suppose your goal is to have 500,000 dollars at the start of your retirement.
So how do you get that amount of money? One way is to start investing
at the earliest possible age. For example, if you start to invest 30 years
before you retire and receive an average return of 6 percent on your investments,
you need to invest 498 dollars each month for 30 years, a total of 179,191
dollars. But if you wait until 10 years before your retirement, you must
invest 3,051 dollars each month or a total of 366,123 dollars. The conclusion
is obvious - start saving and investing at the earliest possible age.
People who make systematic investments many years before they retire have
time on their side to allow their investments to grow to very large amounts.
But people who wait to invest until a few years before retirement have
to play catch up and must invest very large amounts of money during their
final years at work.
What does this simple example teach? You need a very large pile of money
for retirement and you should start saving and investing many years before
you retire.
Eat Your Spinach
In the following chapters, we contrast what we think prudent fiscal behavior is with that we think isn’t. We base our arguments on facts and observations of two kinds: data available in the cited sources, and our experience and that of our acquaintances. The moral is simple. More responsible fiscal behavior early will result in a better life later, and it can be achieved while still enjoying life. At the extreme, nobody we know of ever has died from eating spinach (although Popeye may have married Olive Oil, we don’t know). But if you don’t eat your financial spinach young, you run the risk of living on real spinach and little else later.
We think even those who are in or near retirement can benefit from reading this book, but it is especially aimed at what we call “the young”. We define “young” as anyone with a potential 20 year investment life ahead of them. Since many of us will continue earning until we are 70 or older, this includes everyone up to at least the age of 50.
Where to Buy
You can order this book in hardcover or paperback from XLibris.
